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BOOMS, RECESSIONS AND FINANCIAL TURMOIL: A FRESH LOOK AT INVESTMENT DECISIONS UNDER CYCLICAL UNCERTAINTY

52 citations0/0 files storedScottish Journal of Political Economy

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Capital Investment and Risk Analysis Stochastic processes and financial applications Innovation Diffusion and Forecasting

Abstract

ABSTRACT The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between three different states, each with different rates of drift and volatility. In our setting, the shifts are governed by a three‐state Markov switching model with constant transition probabilities. The magnitude of the link between cyclical uncertainty and investment is quantified using simulations of the model. The chief implication of the model is that recessions and financial turmoil are important catalysts for waiting. In other words, our model shows that macroeconomic risk acts as an important deterrent to investments.

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References

1989A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle 1994Investment Under Uncertainty.1994Investment under Uncertainty 1989Entry and Exit Decisions under Uncertainty 1988Patterns of Firm Entry and Exit in U.S. Manufacturing Industries 2000Understanding Productivity: Lessons from Longitudinal Microdata 1995Frontiers of Business Cycle Research 1990Long Swings in the Dollar: Are They in the Data and Do Markets Know It?

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