Lags, Convexity and the Investment-Uncertainty Relationship

Abstract

The effect that investment lags has on the uncertainty-investment relationship is studied by modifying the Bar-Ilan and Strange (1996) model in a manner that enables analytical solution. It turns out that: (i) If the time lag is sufficiently small, uncertainty affects investment negatively; (ii) A sufficiently large time lag engenders an inverse u-shape relationship between the degree of uncertainty and the profit level that triggers investment; (iii) When such an inverse u-shape exists, the higher is the length of the time lag (or the degree of profit convexity) the wider is the range of a positive uncertainty-investment relationship.

JEL Classification: D81