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Time to Build Capital: Revisiting Investment-Cash Flow Sensitivities

  • Tsoukalas, John

A large body of empirical work has established the significance of cash flow in explain- ing investment dynamics. This finding is further taken as evidence of capital market imperfections. We show, using a perfect capital markets model, that time-to-build for capital projects creates an investment cash flow sensitivity as found in empiri- cal studies that may not be indicative of capital market frictions. The result is due to mis-specification present in empirical investment-q equations under time-to-build investment. In addition, time aggregation error can give rise to cash flow effects inde- pendently of the time-to-build effect. Importantly, both errors arise independently of potential measurement error in q. We provide implications and recommendations for empirical work.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 25870.

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Date of creation: 2009
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Handle: RePEc:pra:mprapa:25870
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