Uncertainty and Investment Dynamics

Nicholas Bloom (), John van Reenen () and Stephen Bond

No 12383, NBER Working Papers from National Bureau of Economic Research, Inc

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 %u2013 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.

JEL-codes: D92 E22 D8 C23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-fmk and nep-mac
Date: 2006-07
Note: EFG PR
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Working Paper: Uncertainty and Investment Dynamics (2006)
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