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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)
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Abstract

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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.

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