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Uncertainty and investment dynamics

Van Reenen, John and Bloom, Nick and Bond, Steve (2006) Uncertainty and investment dynamics. 739. London School of Economics and Political Science, Centre for Economic Performance, London, UK.

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Identification Number: 739

Abstract

This paper shows that, with (partial) irreversibility, higher uncertainty reduces the impact effect of demand shocks on investment. Uncertainty increases real option values making firms more cautious when investing or disinvesting. This is confirmed both numerically for a model with a rich mix of adjustment costs, time-varying uncertainty, and aggregation over investment decisions and time, and also empirically for a panel of manufacturing firms. These cautionary effects of uncertainty are large - going from the lower quartile to the upper quartile of the uncertainty distribution typically halves the first year investment response to demand shocks. This implies the responsiveness of firms to any given policy stimulus may be much lower in periods of high uncertainty, such as after major shocks like OPEC I and 9/11.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk
Additional Information: © 2006 Centre for Economic Performance, LSE.
Subjects: H Social Sciences > HG Finance
Sets: Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Departments > Economics
Date Deposited: 13 Aug 2007
Last Modified: 01 Oct 2010 08:47
URI: http://eprints.lse.ac.uk/id/eprint/2645

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