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What do We Know About Investment Under Uncertainty?

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  • Alan Carruth
  • Andy Dickerson
  • Andrew Henley

Abstract

Recent theoretical developments relating to investment under uncertainty have highlighted the importance of irreversibility for the timing of investment expenditures and their expected returns. This has subsequently stimulated a growing empirical literature which examines uncertainty and threshold effects on investment behaviour. This paper presents a review of this literature. A variety of methods have been used to investigate the empirical implication of irreversibility in investment, the majority focusing on the relationship between investment flows and proxy measures of uncertainty. A general conclusion is that increased uncertainty, at both aggregate and disaggregate levels, leads to lower investment rates. This suggests that there is an irreversibility effect, under which greater uncertainty raises the value of the ‘call option’ to delay a commitment to investment. This effect appears to dominate any positive impact on investment arising from the fact that greater uncertainty, under certain circumstances, increases the marginal profitability of capital. The methods used raise a number of issues which call into question the reliability of the findings, and these are addressed in the paper. However, if such irreversibility effects are present, then their omission from traditional investment models casts doubt on the efficacy of such specifications. JEL Classification: D81, D92, E22

Suggested Citation

  • Alan Carruth & Andy Dickerson & Andrew Henley, 2000. "What do We Know About Investment Under Uncertainty?," Journal of Economic Surveys, Wiley Blackwell, vol. 14(2), pages 119-154, April.
  • Handle: RePEc:bla:jecsur:v:14:y:2000:i:2:p:119-154
    DOI: 10.1111/1467-6419.00107
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    Cited by:

    1. Mustafa Caglayan & Rebeca Muñoz Torres, 2011. "The Effect of the Exchange Rates on Investment in Mexican Manufacturing Industry," Open Economies Review, Springer, vol. 22(4), pages 669-683, September.
    2. Jonathan P. O'Brien & Timothy B. Folta & Douglas R. Johnson, 2003. "A real options perspective on entrepreneurial entry in the face of uncertainty," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 24(8), pages 515-533.
    3. Alan Carruth & Andrew Dickerson & Andrew Henley, 2000. "Econometric Modelling of UK Aggregate Investment: The Role of Profits and Uncertainty," Manchester School, University of Manchester, vol. 68(3), pages 276-300, June.
    4. Ahmadi, Maryam & Manera, Matteo & Sadeghzadeh, Mehdi, 2019. "The investment-uncertainty relationship in the oil and gas industry," Resources Policy, Elsevier, vol. 63(C), pages 1-1.
    5. Ronald MacDonald, 2000. "The role of the exchange rate in economic growth: a euro-zone perspective," Working Paper Research 09, National Bank of Belgium.
    6. Christiansen, Arndt, 2005. "Der "more economic approach" in der EU-Fusionskontrolle - eine kritische Würdigung," Research Notes 21, Deutsche Bank Research.
    7. Alexander Cobham, "undated". "Making Bad Decisions: firm size and investment under uncertainty," QEH Working Papers qehwps39, Queen Elizabeth House, University of Oxford.
    8. Julia Darby & Andrew Hughes Hallett & Jonathan Ireland & Laura Piscitelli, 2000. "Exchange Rate Uncertainty and Business Sector Investment," Econometric Society World Congress 2000 Contributed Papers 0600, Econometric Society.
    9. Engelbert Stockhammer, 2007. "Some Stylized Facts on the Finance-Dominated Accumulation Regime," Working Papers wp142, Political Economy Research Institute, University of Massachusetts at Amherst.
    10. Timothy B. Folta & Jonathan P. O'Brien, 2008. "Determinants of firm-specific thresholds in acquisition decisions," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(2-3), pages 209-225.

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    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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