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The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling

  • Ryan Kellogg

Despite widespread application of real options theory in the literature, the extent to which firms actually delay irreversible investments following an increase in the uncertainty of their environment is not empirically well-known. This paper estimates firms' responsiveness to changes in uncertainty using detailed data on oil well drilling in Texas and expectations of future oil price volatility derived from the NYMEX futures options market. Using a dynamic model of firms' investment problem, I find that oil companies respond to changes in expected price volatility by adjusting their drilling activity by a magnitude consistent with the optimal response prescribed by theory.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16541.

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Date of creation: Nov 2010
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Publication status: published as Ryan Kellogg, 2014. "The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling," American Economic Review, American Economic Association, vol. 104(6), pages 1698-1734, June.
Handle: RePEc:nbr:nberwo:16541
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  16. Leahy, John V & Whited, Toni M, 1996. "The Effect of Uncertainty on Investment: Some Stylized Facts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(1), pages 64-83, February.
  17. Szakmary, Andrew & Ors, Evren & Kyoung Kim, Jin & Davidson, Wallace III, 2003. "The predictive power of implied volatility: Evidence from 35 futures markets," Journal of Banking & Finance, Elsevier, vol. 27(11), pages 2151-2175, November.
  18. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September.
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