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Uncertainty and Investment Dynamics

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

CEP Discussion Papers from Centre for Economic Performance, LSE

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.

Keywords: Investment; uncertainty; real options; panel data (search for similar items in EconPapers)
JEL-codes: D92 E22 D8 C23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cfn and nep-mac
Date: 2006-08
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http://cep.lse.ac.uk/pubs/download/dp0739.pdf (application/pdf)

Related works:
Journal Article: Uncertainty and Investment Dynamics (2007) Downloads
Working Paper: Uncertainty and investment dynamics (2006) Downloads
Working Paper: Uncertainty and Investment Dynamics (2006) Downloads
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