To buy or not to buy? Uncertainty, irreversibility, and heterogeneous investment dynamics in Italian company data

Abstract

This study tests for the presence of real options effects induced by uncertainty and (partial) irreversibility on fixed capital investment using Italian company data. Our approach recognizes that firm-level investment spending may, itself be aggregated over multiple investment decisions in separate types of capital goods and emphasizes effects of uncertainty on short-run investment dynamics. Using a survey-based measure of uncertainty related to the assessment of managers responsible for the firms' investment plans, we find evidence of heterogeneous and nonlinear dynamics pointing to a slower adjustment of investment in response to demand shocks at higher levels of uncertainty. Our results also point to an additional source of nonlinearity originating from a convex response of investment to demand shocks. © 2007 International Monetary Fund.