Subjective Uncertainty, Expectations, and Firm Behavior

Based on a large and representative panel of German firms, this paper relates a novel measure of subjective uncertainty to business expectations and firm decisions. Uncertainty is measured by asking managers directly how uncertain they are about their future business development. I show that the relationship between perceived uncertainty and expectations is strongly negative at the micro level and almost perfectly inverse in the aggregate. It is also state-dependent: uncertainty co-moves less with expectations in bad times. In a case study at the onset of the COVID-19 recession, I exploit the between-firm variation in firms' uncertainty and expectations to examine the implications of the ``real options'' theory. I find that changes in uncertainty during the aggregate downturn do not predict ``wait and see'' behavior. By contrast, first moment changes are related to investments deferral and a reduction of the workforce.