Investment Under Uncertainty

43 Pages Posted: 23 Mar 2007

See all articles by Sergei Antoshin

Sergei Antoshin

George Washington University, School of Business; International Monetary Fund

Date Written: November 2006

Abstract

A real options theory - in its classic formulation - suggests that firms invest less during times of high uncertainty, that is, uncertainty depresses investment. However, several theoretical extensions predict that the relationship between investment and uncertainty may be non-linear, or even non-monotonic, when classic model assumptions are violated. Some model parameters either reinforce or weaken the negative effect of uncertainty on investment, while others distort the investment-uncertainty relationship, making it follow an inverted U-curve. This paper is a first - to my knowledge - attempt to identify the factors affecting investment from various streams of theoretical literature on investor choice and uncertainty, and to assemble them in a single empirical framework. By employing a dynamic panel of oil company data and implied volatilities as measures of uncertainty, I am able to examine the impact of uncertainty on investment and the effect of several factors on the investment-uncertainty relationship. I obtain evidence in support of several predictions from the theory. Both economy-wide and firm-specific types of uncertainty, as well as financing constraints, are found to adversely affect investment, while industry-wide uncertainty has an ambiguous effect, depending on the level of output price. In tests for non-linearity in the investment-output price volatility relationship, I find that output price, firm size and its risk management ability weaken the investment-uncertainty relationship. On the other hand, market imperfection, financing constraints, the firm's maturity and its risk aversion re-enforce the negative effect of uncertainty. In addition, adjustment costs seem to be considerable, as firm investment reacts to changes in macroeconomic conditions with a noticeable delay.

Keywords: investment choice, real options, uncertainty, volatility, oil price

JEL Classification: C3, C5, D4, D8, G1

Suggested Citation

Antoshin, Sergei, Investment Under Uncertainty (November 2006). Available at SSRN: https://ssrn.com/abstract=972722 or http://dx.doi.org/10.2139/ssrn.972722

Sergei Antoshin (Contact Author)

George Washington University, School of Business ( email )

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Washington, DC 20052
United States
202-362-7008 (Phone)

HOME PAGE: http://savickas.net/cgi-bin/GWfinance/viewfaculty.cgi?fn=36

International Monetary Fund ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-7630 (Phone)

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