EVIDENCE ON THE RELATIONSHIP BETWEEN UNCERTAINTY AND IRREVERSIBLE INVESTMENT

Recent theoretical literature on irreversible investment has suggested that increased uncertainty about (i.e., volatility of) exogenous factors depresses investment. However, empirical confirmation of the theory has been minimal. This paper considers five major uncertainty variables, namely, the growth rates of real interest rate, personal consumption, composite index of leading indicators, index of stock prices and GDP deflator. Their conditional variance is estimated using ARCH methodology and is related to growth in fixed private investment. The latter type of investment is assumed to be largely irreversible. The results show a significant negative relationship between uncertainty and investment, thereby confirming the received theory.