Investment and Demand Uncertainty

Luigi Guiso and Giuseppe Parigi

No 1497, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Theoretical models of investment under uncertainty predict that the sign and the strength of the investment-uncertainty relationship is in principle ambiguous and can vary greatly across groups of firms depending on the degree of irreversibility of investment and the market power of the firm. This paper investigates the effects of uncertainty on the investment decisions of a sample of Italian manufacturing firms, using information on the subjective probability distribution of future demand for firms’ products according to entrepreneurs. The results support the view that uncertainty slows down capital accumulation. Consistent with the predictions of the theory, there is considerable heterogeneity in the effect of uncertainty on investment: it is stronger for firms that cannot easily reverse investment decisions and for those with substantial market power. We show that the negative effect of uncertainty on investment cannot be explained by uncertainty proxying for liquidity constraints, credit rationing being more likely among riskier firms. Evidence of a negative effect of past uncertainty on hours currently worked reinforces the conclusion of a negative relationship between uncertainty and investment.

Keywords: Demand Uncertainty; Investment; Irreversibility (search for similar items in EconPapers)
JEL-codes: D80 E22 (search for similar items in EconPapers)
Date: 1996-11
References: Add references at CitEc
Citations: View citations in EconPapers (9)

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Related works:
Journal Article: Investment and Demand Uncertainty (1999)
Working Paper: Investment and Demand Uncertainty (1996)
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