American Economic Review2014-07-04 5:39 PM

The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling

Abstract

This paper estimates the response of investment to changes in uncertainty using data on oil drilling in Texas and the expected volatility of the future price of oil. Using a dynamic model of firms’ investment problem, I find that: (i) the response of drilling activity to changes in price volatility has a magnitude consistent with the optimal response prescribed by theory, (ii) the cost of failing to respond to volatility shocks is economically significant, and (iii) implied volatility data derived from futures options prices yields a better fit to firms’ investment behavior than backward-looking volatility measures such as GARCH.

 

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http://dx.doi.org/10.1257/aer.104.6.1698

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American Economic Review

The American Economic Review is a general-interest economics journal. Established in 1911, the AER is among the nation's oldest and most respected scholarly journals in the economics profession.

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