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To Buy or Not to Buy? Uncertainty, Irreversibility and Heterogeneous Investment Dynamics in Italian Company Data

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  • Domenico Lombardi
  • Stephen Bond
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    Abstract

    This study tests for the presence of real options effects induced by uncertainty and (partial) irreversibility on fixed capital investment using Italian company data. The approach recognizes that firm-level investment spending may, itself, be aggregated over multiple investment decisions in separate types of capital goods and emphasizes effects of uncertainty on short-run investment dynamics. Using a survey-based measure of uncertainty related to the assessment of managers responsible for the firms'' investment plans, the study finds evidence of heterogeneous and nonlinear dynamics pointing to a slower adjustment of investment in response to demand shocks at higher levels of uncertainty. The results also point to an additional source of nonlinearity originating from a convex response of investment to demand shocks.

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    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=17196
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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/104.

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    Length: 29
    Date of creation: 01 Jun 2004
    Date of revision:
    Handle: RePEc:imf:imfwpa:04/104

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    Web page: http://www.imf.org/external/pubind.htm
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    Related research

    Keywords: Economic models; capital stock; survey; equations; measure of uncertainty; cost of capital; statistics; correlation; predictions; finite sample; capital accumulation; capital goods; standard errors; descriptive statistics; equation; samples; capital expenditures; sample bias; logarithm; monte carlo simulations; prediction; nonlinearity; capital market; capital adjustment; functional form; statistic; frequency distribution; logarithms; level productivity; random sample; stock market; quality control; econometrics; error variance; surveys; significance levels; number of variables; capital market imperfections;

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    References

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    1. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 87(1), pages 115-143, August.
    2. Øivind Anti Nilsen & Fabio Schiantarelli, 2003. "Zeros and Lumps in Investment: Empirical Evidence on Irreversibilities and Nonconvexities," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1021-1037, November.
    3. Hall, B. & Mairesse, J. & Mulkay, B., 1998. "Firm-Level Investment in France and the United States: An Exploration of What We Have Learned in Twenty Years," Economics Papers 143, Economics Group, Nuffield College, University of Oxford.
    4. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
    5. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
    6. Mark Doms & Timothy Dunne, 1994. "Capital Adjustment Patterns in Manufacturing Plants," Working Papers 94-11, Center for Economic Studies, U.S. Census Bureau.
    7. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 193-225, March.
    8. Robert Carpenter & Laura Rondi, 2000. "Italian Corporate Governance, Investment, and Finance," Empirica, Springer, vol. 27(4), pages 365-388, December.
    9. Simon G. Gilchrist & Ben Bernanke & Mark Gertler, 1994. "The financial accelerator and the flight to quality," Finance and Economics Discussion Series 94-18, Board of Governors of the Federal Reserve System (U.S.).
    10. Nucci, Francesco & Pozzolo, Alberto F., 2001. "Investment and the exchange rate: An analysis with firm-level panel data," European Economic Review, Elsevier, vol. 45(2), pages 259-283, February.
    11. Nickell, Stephen J, 1977. "The Influence of Uncertainty on Investment," Economic Journal, Royal Economic Society, vol. 87(345), pages 47-70, March.
    12. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
    13. Alan Carruth & Andy Dickerson & Andrew Henley, 1998. "What Do We Know About Investment Under Uncertainty?," Studies in Economics 9804, Department of Economics, University of Kent.
    14. Dixit, Avinash, 1997. "Investment and Employment Dynamics in the Short Run and the Long Run," Oxford Economic Papers, Oxford University Press, vol. 49(1), pages 1-20, January.
    15. Frank Windmeijer, 2000. "A finite sample correction for the variance of linear two-step GMM estimators," IFS Working Papers W00/19, Institute for Fiscal Studies.
    16. R. Gaston Gelos & Alberto Isgut, 2001. "Fixed Capital Adjustment: Is Latin America Different?," The Review of Economics and Statistics, MIT Press, vol. 83(4), pages 717-726, November.
    17. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
    18. Abel, Andrew B & Eberly, Janice C, 1996. "Optimal Investment with Costly Reversibility," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 581-93, October.
    19. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
    20. Luigi Guiso & Giuseppe Parigi, 1999. "Investment And Demand Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 114(1), pages 185-227, February.
    21. Ricardo J. Caballero & Eduardo M. R. A. Engel & John C. Haltiwanger, 1995. "Plant-Level Adjustment and Aggregate Investment Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 1-54.
    22. Bond, Stephen & Van Reenen, John, 2007. "Microeconometric Models of Investment and Employment," Handbook of Econometrics, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 6, chapter 65 Elsevier.
    23. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
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    Citations

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    Cited by:
    1. Domenico Lombardi & Stephen Bond, 2005. "Why is Micro Evidenceon the Effects of Uncertainty Not Replicated in Macro Data?," IMF Working Papers 05/158, International Monetary Fund.
    2. Juan de Dios Tena & Francesco Giovannoni, 2005. "Market Concentration, Macroeconomic Uncertainty and Monetary Policy," Bristol Economics Discussion Papers 05/576, Department of Economics, University of Bristol, UK.

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