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A Generalised Model of Investment under Uncertainty: Aggregation and Estimation

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Author Info
Nicholas Bloom (University College London)

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Abstract

We propose a structural model of investment which is based on the aggregation of (S,s) investment projects within firms. This encompasses the findings that whilst firm level investment is smooth, plant level investment is lumpy and frequently zero. We undertake stochastic aggregation and derive a structural firm level investment estimator.
The empirical performance and fit of this estimator on a panel of manufacturing firms is encouraging and provides an avenue for general policy simulation. This model also explains the rich non-linear dynamics of firm level investment data and the frequent simultaneity of firm level investment and disinvestment. This approach provides an alternative structural estimator to the standard convex adjustment cost models, such as Tobin's Q and the Euler equation. The is important because these estimators, which assume quadratic adjustment costs, appear to be misspecified and subject to a fallacy of composition between smooth firm level investment and lumpy plant level investment.
For completeness we also consider time aggregation as an alternative source of smoothing but statistically reject this as being insufficient to smooth investment alone. This test also rejects most plant level data, such as the US\ LRD and UK\ ARD, as being generated from a single (S,s) process.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1505.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1505

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  4. Bond, Stephen & Meghir, Costas, 1994. "Dynamic Investment Models and the Firm's Financial Policy," Review of Economic Studies, Blackwell Publishing, vol. 61(2), pages 197-222, April. [Downloadable!] (restricted)
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  5. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October. [Downloadable!] (restricted)
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  6. John Sutton, 1996. "Gibrats Legacy," STICERD - Economics of Industry Papers 14, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE. [Downloadable!]
  7. Richard Hartman & Michael Hendrickson, 1999. "Optimal Partially Reversible Investment," Discussion Papers in Economics at the University of Washington 0032, Department of Economics at the University of Washington. [Downloadable!]
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  9. Giuseppe Bertola & Ricardo J. Caballero, 1990. "Kinked Adjustment Costs and Aggregate Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 237-296 National Bureau of Economic Research, Inc. [Downloadable!]
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  10. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-85, December. [Downloadable!] (restricted)
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  11. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Blackwell Publishing, vol. 61(2), pages 223-46, April. [Downloadable!] (restricted)
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  12. Robert G. King & Charles I. Plosser & James H. Stock & Mark W. Watson, 1991. "Stochastic trends and economic fluctuations," Working Paper Series, Macroeconomic Issues 91-4, Federal Reserve Bank of Chicago.
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  13. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June. [Downloadable!] (restricted)
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  16. Andrew Caplin & John Leahy, 1999. "Durable Goods Cycles," NBER Working Papers 6987, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Mark E. Doms & Timothy Dunne, 1998. "Capital Adjustment Patterns in Manufacturing Plants," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(2), pages 409-429, April. [Downloadable!] (restricted)
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  18. Dixit, Avinash, 1991. "Analytical Approximations in Models of Hysteresis," Review of Economic Studies, Blackwell Publishing, vol. 58(1), pages 141-51, January. [Downloadable!] (restricted)
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  20. Richard Hartman & Michael Hendrickson, 1999. "Optimal Partially Reversible Investment," Working Papers 0032, University of Washington, Department of Economics. [Downloadable!]
  21. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  22. Russell Cooper & John Haltiwanger & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September. [Downloadable!] (restricted)
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