Journal Article

Uncertainty and Investment Dynamics

Nick Bloom, Stephen Bond and John Van Reenen

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 74, issue 2, pages 391-415
Published in print April 2007 | ISSN: 0034-6527
Published online April 2007 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2007.00426.x
Uncertainty and Investment Dynamics

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  • Information, Knowledge, and Uncertainy
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This paper shows that with (partial) irreversibility higher uncertainty reduces the responsiveness of investment to demand shocks. 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 weaker in periods of high uncertainty, such as after the 1973 oil crisis and September 11, 2001.

Keywords: D81; G31; L60

Journal Article.  11783 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Manufacturing ; Corporate Governance

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