DP4025 Uncertainty and Company Investment Dynamics: Empirical Evidence for UK Firms

Author(s): Nicholas Bloom , Stephen Roy Bond , John Van Reenen

Publication Date: August 2003

Keyword(s): investment , uncertainty , real options , panel data

JEL(s): C23 , D80 , D92 , E22

Programme Areas: Industrial Organization

Link to this Page: www.cepr.org/pubs/dps/DP4025.asp

This Paper investigates the empirical relationship between uncertainty and investment dynamics. This is motivated by the real options literature, which suggests a weaker response of investment to demand shocks at higher levels of uncertainty, as firms place a greater value on the option to wait. Using simulated data we show that this more cautious behaviour can be detected as a smaller impact of sales growth on investment for firms facing higher uncertainty. Using a stock returns volatility measure of uncertainty for a large panel of quoted UK companies, we find a similar interaction effect in our econometrics analysis.