Cyclical uncertainty and physical investment decisions

Yu-Fu Chen, Michael Funke

    Research output: Working paperDiscussion paper

    47 Downloads (Pure)

    Abstract

    The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between two different states, each with different rates of drift and volatility. In our setting the shifts are governed by a two-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 are important catalysts for waiting. In other words, our model shows that macroeconomic risk acts as a deterrent to present investments.
    Original languageEnglish
    PublisherUniversity of Dundee
    Publication statusPublished - 2004

    Publication series

    NameDundee Discussion Papers in Economics
    PublisherUniversity of Dundee
    No.169
    ISSN (Print)1473-236X

    Fingerprint

    Investment decision
    Uncertainty
    Macroeconomics
    Recession
    Transition probability
    Real options
    Markov switching model
    Simulation
    Catalyst
    Interaction

    Keywords

    • Business cycles
    • Real options
    • Investment
    • Markov switching
    • Tobin’s q
    • Uncertainty

    Cite this

    Chen, Y-F., & Funke, M. (2004). Cyclical uncertainty and physical investment decisions. (Dundee Discussion Papers in Economics; No. 169). University of Dundee.
    Chen, Yu-Fu ; Funke, Michael. / Cyclical uncertainty and physical investment decisions. University of Dundee, 2004. (Dundee Discussion Papers in Economics; 169).
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    Chen, Y-F & Funke, M 2004 'Cyclical uncertainty and physical investment decisions' Dundee Discussion Papers in Economics, no. 169, University of Dundee.

    Cyclical uncertainty and physical investment decisions. / Chen, Yu-Fu; Funke, Michael.

    University of Dundee, 2004. (Dundee Discussion Papers in Economics; No. 169).

    Research output: Working paperDiscussion paper

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    T1 - Cyclical uncertainty and physical investment decisions

    AU - Chen, Yu-Fu

    AU - Funke, Michael

    PY - 2004

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    N2 - The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between two different states, each with different rates of drift and volatility. In our setting the shifts are governed by a two-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 are important catalysts for waiting. In other words, our model shows that macroeconomic risk acts as a deterrent to present investments.

    AB - The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between two different states, each with different rates of drift and volatility. In our setting the shifts are governed by a two-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 are important catalysts for waiting. In other words, our model shows that macroeconomic risk acts as a deterrent to present investments.

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    KW - Real options

    KW - Investment

    KW - Markov switching

    KW - Tobin’s q

    KW - Uncertainty

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    Chen Y-F, Funke M. Cyclical uncertainty and physical investment decisions. University of Dundee. 2004. (Dundee Discussion Papers in Economics; 169).