The Real Options Effect of Uncertainty on Investment and Labor Demand

IFS Working Paper No. W00/15

34 Pages Posted: 6 Feb 2001

See all articles by Nicholas Bloom

Nicholas Bloom

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: December 2000

Abstract

This paper shows that, contrary to common beliefs, the real options effect of uncertainty plays no role in the long run rate of investment. This is proven for both the standard investment model with Cobb-Douglas production and Brownian motion demand, and also for a broader class of models with multiple lines of capital, labor and general demand stochastics. Real options and irreversibility, however, are shown to play an important role in the short run dynamics of investment and labor demand. Specifically, they reduce the short run response of investment and hiring to current demand shocks, and lead to a lagged response to past demand shocks.

Keywords: Investment, Labor Demand, Uncertainty, Real Options

JEL Classification: D92, E22, D8

Suggested Citation

Bloom, Nicholas, The Real Options Effect of Uncertainty on Investment and Labor Demand (December 2000). IFS Working Paper No. W00/15, Available at SSRN: https://ssrn.com/abstract=254268 or http://dx.doi.org/10.2139/ssrn.254268

Nicholas Bloom (Contact Author)

Stanford University - Department of Economics ( email )

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HOME PAGE: http://economics.stanford.edu/faculty/bloom

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