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Uncertainty and investment dynamics

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

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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: C23 E22 D8 D92 (search for similar items in EconPapers)
Date: 2006-08
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http://eprints.lse.ac.uk/2645/ Open access version. (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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