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Firm Investment and the Term Structure of Uncertainty

Author

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  • Ian Wright

    (Stanford University)

Abstract
Why has firm activity been slow to recover from the Great Recession? I present theoretical and empirical evidence suggesting long-term uncertainty may be one reason. Specifically, I show the current level of uncertainty and expectations of future uncertainty -- that is, the entire term structure of uncertainty -- are negatively correlated with firm investment rates. I present a simple model generating these effects through real options channels. Using equity options to obtain forward-looking estimates of firm and aggregate uncertainty at different horizons, I then show that both the level and slope of the term structure of uncertainty have negative conditional correlations with capital investment rates, consistent with the model. Numerically, a one standard deviation increase in firm (aggregate) uncertainty over the next year relative to the next 30 days correlates with a decrease in firm capital investment equal to 3.1% (4.4%) of the mean firm investment rate over the next quarter. I also find the correlation between both short- and long-term uncertainty and R&D to be positive, supporting the theory that firms invest in growth options in the face of uncertainty. I discuss identification in this context and the particular relevance of my findings for government policy.

Suggested Citation

  • Ian Wright, 2015. "Firm Investment and the Term Structure of Uncertainty," Economics Working Papers 15104, Hoover Institution, Stanford University.
    • Handle: RePEc:hoo:wpaper:15104
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    References listed on IDEAS

    as
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    Cited by:

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    3. Bugshan, Abdullah, 2022. "Oil price volatility and corporate cash holding," Journal of Commodity Markets, Elsevier, vol. 28(C).

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