Hostname: page-component-cd9895bd7-gbm5v Total loading time: 0 Render date: 2024-12-27T20:40:03.216Z Has data issue: false hasContentIssue false
  • English
  • Français

The Impact of Uncertainty on Investment: Empirical Challenges and a New Estimator

Published online by Cambridge University Press:  20 February 2023

Delong Li Open the ORCID record for Delong Li [Opens in a new window]  and
Yiguo Sun
Delong Li*
Affiliation:
University of Guelph Gordon S. Lang School of Business and Economics and Cornerstone Research
Yiguo Sun
Affiliation:
University of Guelph Gordon S. Lang School of Business and Economics yisun@uoguelph.ca
*
delong.li@cornerstone.com (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

This article proposes a new method for examining the impact on a firm’s investment of uncertainty reflected in its stock-return volatility. We simultaneously address the endogeneity of uncertainty and mismeasurement in Tobin’s Q, but earlier empirical work often neglects one of the two issues. Our nonparametric estimates further suggest that the relation between investment and uncertainty is significantly decreasing and strongly concave. This result contrasts with the existing literature that widely adopts linear regressions. Ignoring nonlinearity or measurement error in Q can lead to a substantial estimation bias. However, the bias due to the endogeneity of uncertainty is small.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 1 , February 2024 , pp. 307 - 338
Creative Commons
Creative Common License - CCCreative Common License - BYCreative Common License - NCCreative Common License - ND
This is an Open Access article, distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives licence (http://creativecommons.org/licenses/by-nc-nd/4.0), which permits non-commercial re-use, distribution, and reproduction in any medium, provided that no alterations are made and the original article is properly cited. The written permission of Cambridge University Press must be obtained prior to any commercial use and/or adaptation of the article.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We appreciate comments from seminar participants at the Econometric Society Asian meeting, China meeting, and North American summer meeting in 2019, Northern Finance Association 2019 conference (especially our discussant, Georgios Skoulakis), Bank of Finland, Shanghai University of Finance and Economics, and Wilfrid Laurier University. We give special thanks to Paul Malatesta (the editor) and Iulian Obreja (the referee) for detailed comments and helpful suggestions, and to the Social Sciences and Humanities Research Council of Canada (grant ID 430-2022-00119) for financial supports. In addition, Li coauthored this article before joining Cornerstone Research. The views expressed herein are solely those of the authors who are responsible for the content, and do not necessarily represent the views of Cornerstone Research.

References

Abel, A. B. “Optimal Investment Under Uncertainty.” American Economic Review, 73 (1983), 228–233.Google Scholar
Abel, A. B. “The Effects of Q and Cash Flow on Investment in the Presence of Measurement Error.” Journal of Financial Economics, 128 (2018), 363–377.CrossRefGoogle Scholar
Alfaro, I.; Bloom, N.; and Lin, X.. “The Finance Uncertainty Multiplier.” NBER Working Paper No. 24571 (2022).Google Scholar
Allayannis, G., and Mozumdar, A.. “The Impact of Negative Cash Flow and Influential Observations on Investment–Cash Flow Sensitivity Estimates.” Journal of Banking & Finance, 28 (2004), 901–930.CrossRefGoogle Scholar
Almeida, H.; Campello, M.; and Galvao, A. F.. “Measurement Errors in Investment Equations.” Review of Financial Studies, 23 (2010), 3279–3328.CrossRefGoogle Scholar
Alnahedh, S.; Bhagat, S.; and Obreja, L.. “Employment, Corporate Investment, and Cash-Flow Risk.” Journal of Financial and Quantitative Analysis, 54 (2019), 1855–1898.CrossRefGoogle Scholar
Arellano, M., and Bond, S.. “Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations.” Review of Economic Studies, 58 (1991), 277–297.CrossRefGoogle Scholar
Balasubramanian, N., and Sivadasan, J.. “Capital Resalability, Productivity Dispersion, and Market Structure.” Review of Economics and Statistics, 91 (2009), 547–557.CrossRefGoogle Scholar
Belloni, A.; Chen, D.; Chernozhukov, V.; and Hansen, C.. “Sparse Models and Methods for Optimal Instruments with an Application to Eminent Domain.” Econometrica, 80 (2012), 2369–2429.Google Scholar
Bernanke, B. S.; Gertler, M.; and Gilchrist, S.. “The Financial Accelerator in a Quantitative Business Cycle Framework.” In Handbook of Macroeconomics, Vol. 1. Amsterdam: Elsevier (1999), 1341–1393.CrossRefGoogle Scholar
Bester, C. A.; Conley, T. G.; Hansen, C. B.; and Vogelsang, T. J.. “Fixed-b Asymptotics for Spatially Dependent Robust Nonparametric Covariance Matrix Estimators.” Econometric Theory, 32 (2016), 154–186.CrossRefGoogle Scholar
Bhagat, S.; Moyen, N.; and Suh, I.. “Investment and Internal Funds of Distressed Firms.” Journal of Corporate Finance, 11 (2005), 449–472.CrossRefGoogle Scholar
Bloom, N. “Fluctuations in Uncertainty.” Journal of Economic Perspectives, 28 (2014), 153–176.CrossRefGoogle Scholar
Bond, S. R., and Cummins., J. G. “Uncertainty and Investment: An Empirical Investigation Using Data on Analysts’ Profits Forecasts.” Washington, D.C.: Federal Reserve Board (2004).CrossRefGoogle Scholar
Caballero, R. J. “On the Sign of the Investment–Uncertainty Relationship.” American Economic Review, 81 (1991), 279–288.Google Scholar
Carlton, D. W.; Perloff, J. M.; and van ’t Veld, K. T.. Modern Industrial Organization. Glenview, IL: Scott, Foresman/Little, Brown Higher Education (1990).Google Scholar
Chen, Q.; Goldstein, I.; and Jiang, W.. “Price Informativeness and Investment Sensitivity to Stock Price.” Review of Financial Studies, 20 (2007), 619–650.CrossRefGoogle Scholar
Chirinko, R. S., and Schaller, H.. “The Irreversibility Premium.” Journal of Monetary Economics, 56 (2009), 390–408.CrossRefGoogle Scholar
Cleary, S.; Povel, P.; and Raith, M.. “The U-Shaped Investment Curve: Theory and Evidence.” Journal of Financial and Quantitative Analysis, 42 (2007), 1–39.CrossRefGoogle Scholar
Dixit, A. K., and Pindyck, R. S., Investment Under Uncertainty. Princeton, NJ: Princeton University Press (1994).CrossRefGoogle Scholar
Doshi, H.; Kumar, P.; and Yerramilli, V.. “Uncertainty, Capital Investment, and Risk Management.” Management Science, 64 (2018), 5769–5786.CrossRefGoogle Scholar
Driscoll, J. C., and Kraay, A. C.. “Consistent Covariance Matrix Estimation with Spatially Dependent Panel Data.” Review of Economics and Statistics, 80 (1998), 549–560.CrossRefGoogle Scholar
Eisdorfer, A. “Empirical Evidence of Risk Shifting in Financially Distressed Firms.” Journal of Finance, 63 (2008), 609–637.CrossRefGoogle Scholar
Erickson, T.; Jiang, C. H.; and Whited, T. M.. “Minimum Distance Estimation of the Errors-in-Variables Model Using Linear Cumulant Equations.” Journal of Econometrics, 183 (2014), 211–221.CrossRefGoogle Scholar
Erickson, T., and Whited, T. M.. “Measurement Error and the Relationship Between Investment and Q.” Journal of Political Economy, 108 (2000), 1027–1057.CrossRefGoogle Scholar
Erickson, T., and Whited, T. M.. “Two-Step GMM Estimation of the Errors-in-Variables Model Using High-Order Moments.” Econometric Theory, 18 (2002), 776–799.CrossRefGoogle Scholar
Erickson, T., and Whited, T. M.. “Treating Measurement Error in Tobin’s Q.” Review of Financial Studies, 25 (2012), 1286–1329.CrossRefGoogle Scholar
Firth, M.; Malatesta, P. H.; Xin, Q.; and Xu, L.. “Corporate Investment, Government Control, and Financing Channels: Evidence from China’s Listed Companies.” Journal of Corporate Finance, 18 (2012), 433–450.CrossRefGoogle Scholar
Gabaix, X., and Koijen, R. S.. “Granular Instrumental Variables.” NBER Technical Report No. 28204 (2020).CrossRefGoogle Scholar
Geary, R. C. “Inherent Relations Between Random Variables.” Proceedings of the Royal Irish Academy. Section A: Mathematical and Physical Sciences, 47 (1941), 63–76.Google Scholar
Gilchrist, S.; Sim, J. W.; and Zakrajšek, E.. “Uncertainty, Financial Frictions, and Investment Dynamics.” NBER Working Paper No. 20038 (2014).CrossRefGoogle Scholar
Greene, W. H., Econometric Analysis. Upper Saddle River, NJ: Pearson (2017).Google Scholar
Gu, L.; Hackbarth, D.; and Johnson, T.. “Inflexibility and Stock Returns.” Review of Financial Studies, 31 (2018), 278–321.CrossRefGoogle Scholar
Gulen, H., and Ion, M.. “Policy Uncertainty and Corporate Investment.” Review of Financial Studies, 29 (2016), 523–564.Google Scholar
Hartman, R. “The Effects of Price and Cost Uncertainty on Investment.” Journal of Economic Theory, 5 (1972), 258–266.CrossRefGoogle Scholar
Hennessy, C. A., and Whited, T. M.. “How Costly Is External Financing? Evidence from a Structural Estimation.” Journal of Finance, 62 (2007), 1705–1745.CrossRefGoogle Scholar
Julio, B., and Yook, Y.. “Political Uncertainty and Corporate Investment Cycles.” Journal of Finance, 67 (2012), 45–83.CrossRefGoogle Scholar
Kim, H., and Kung, H.. “The Asset Redeployability Channel: How Uncertainty Affects Corporate Investment.” Review of Financial Studies, 30 (2017), 245–280.CrossRefGoogle Scholar
Lewellen, J., and Lewellen, K.. “Investment and Cash Flow: New Evidence.” Journal of Financial and Quantitative Analysis, 51 (2016), 1135–1164.CrossRefGoogle Scholar
Li, D.; Magud, N. E.; and Valencia, F.. “Financial Shocks and Corporate Investment in Emerging Markets.” Journal of Money, Credit and Banking, 52 (2020), 613–644.CrossRefGoogle Scholar
Meijer, E.; Spierdijk, L.; and Wansbeek, T.. “Consistent Estimation of Linear Panel Data Models with Measurement Error.” Journal of Econometrics, 200 (2017), 169–180.CrossRefGoogle Scholar
Newey, W. K., and Powell, J. L.. “Instrumental Variable Estimation of Nonparametric Models.” Econometrica, 71 (2003), 1565–1578.CrossRefGoogle Scholar
Newey, W. K.; Powell, J. L.; and Vella, F.. “Nonparametric Estimation of Triangular Simultaneous Equations Models.” Econometrica, 67 (1999), 565–603.CrossRefGoogle Scholar
Oi, W. “The Desirability of Price Instability Under Price Uncertainty.” Econometrica, 29 (1961), 58–64.CrossRefGoogle Scholar
Panousi, V., and Papanikolaou, D.. “Investment, Idiosyncratic Risk, and Ownership.” Journal of Finance, 67 (2012), 1113–1148.CrossRefGoogle Scholar
Patton, A. J., and Sheppard, K.. “Good Volatility, Bad Volatility: Signed Jumps and the Persistence of Volatility.” Review of Economics and Statistics, 97 (2015), 683–697.CrossRefGoogle Scholar
Peters, R. H., and Taylor, L. A.. “Intangible Capital and the Investment–Q Relation.” Journal of Financial Economics, 123 (2017), 251–272.CrossRefGoogle Scholar
Philippon, T. “The Bond market’s Q .” Quarterly Journal of Economics, 124 (2009), 1011–1056.CrossRefGoogle Scholar
Rajan, R. G., and Zingales, L.. “What Do We Know About Capital Structure? Some Evidence from International Data.” Journal of Finance, 50 (1995), 1421–1460.CrossRefGoogle Scholar
Roodman, D. “A Note on the Theme of Too Many Instruments.” Oxford Bulletin of Economics and Statistics, 71 (2009), 135–158.CrossRefGoogle Scholar
Sarkar, S. “On the Investment–Uncertainty Relationship in a Real Options Model.” Journal of Economic Dynamics and Control, 24 (2000), 219–225.CrossRefGoogle Scholar
Schennach, S. M., and Hu, Y.. “Nonparametric Identification and Semiparametric Estimation of Classical Measurement Error Models Without Side Information.” Journal of the American Statistical Association, 108 (2013), 177–186.CrossRefGoogle Scholar
Segal, G.; Shaliastovich, I.; and Yaron, A.. “Good and Bad Uncertainty: Macroeconomic and Financial Market Implications.” Journal of Financial Economics, 117 (2015), 369–397.CrossRefGoogle Scholar
Tibshirani, R. “Regression Shrinkage and Selection via the Lasso.” Journal of the Royal Statistical Society: Series B (Methodological), 58 (1996), 267–288.Google Scholar
Vogelsang, T. J. “Heteroskedasticity, Autocorrelation, and Spatial Correlation Robust Inference in Linear Panel Models with Fixed-Effects.” Journal of Econometrics, 166 (2012), 303–319.CrossRefGoogle Scholar
Wong, K. P. “The Effect of Uncertainty on Investment Timing in a Real Options Model.” Journal of Economic Dynamics and Control, 31 (2007), 2152–2167.CrossRefGoogle Scholar
Zhang, C.-H. “Nearly Unbiased Variable Selection Under Minimax Concave Penalty.” Annals of Statistics, 38 (2010), 894–942.CrossRefGoogle Scholar
Supplementary material: PDF

Li and Sun supplementary material

Online Appendix

Download Li and Sun supplementary material(PDF)
PDF 2.1 MB