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Booms, Recessions and Financial Turmoil: A Fresh Look at Investment Decisions under Cyclical Uncertainty

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Author Info
Yu-Fu Chen
Michael Funke

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Abstract

The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between three different states, each with different rates of drift and volatility. In our setting the shifts are governed by a three-state Markov switching model with constant transition probabilities. The magnitude of the link between cyclical uncertainty and investment is quantified using simulations of the model. The chief implication of the model is that recessions and financial turmoil are important catalysts for waiting. In other words, our model shows that macroeconomic risk acts as an important deterrent to investments.

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File URL: http://www.dundee.ac.uk/econman/discussion/DDPE_225.pdf
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Paper provided by University of Dundee, Economic Studies in its series Discussion Papers with number 225.

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Length: 29 pages
Date of creation: Jun 2009
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Handle: RePEc:dun:dpaper:225

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Related research
Keywords: Business Cycles; Real Options; Investment; Markov Switching; Tobin’s q; Uncertainty;

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

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