THE EFFECTS OF MACROECONOMIC UNCERTAINTY ON IRREVERSIBLE INVESTMENT A Dissertation submitted to the Faculty of the Graduate School of Arts and Sciences of Georgetown University in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Economics By Ayse E, Sile, M. Washington, DC July 2, 2003 pc ) UMI Number: 3107363 Copyright 2003 by Sile, Ayse Esin All rights reserved. INFORMATION TO USERS The quality of this reproduction is dependent upon the quality of the copy submitted. Broken or indistinct print, colored or poor quality illustrations and photographs, print bleed-through, substandard margins, and improper alignment can adversely affect reproduction.
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This microform edition is protected against unauthorized copying under Title 17, United States Code. ProQuest Information and Learning Company 300 North Zeeb Road P. Box 1346 Ann Arbor, MI 48106-1346 Copyright 2003 by Ayse E. Sile All Rights Reserved il ‘GEORGETOWN ; 8 GEORGETOWN UNIVERSITY GRADUATE SCHOOL OF ARTS AND SCIENCES This is to certify that we have examined the doctoral dissertation of Ayse E.
Sile entitled The Effects of Macroeconomic Uncertainty on Irreversible Investment submitted to the faculty of Economics in partial fulfillment of the requirements for the degree of Doctor of Philosophy. This dissertation is complete and satisfactory in all respects, and any and all revisions required by the final examining committee have been made. Collins @ z1 If Sauls, 2, teot : Thesis Advisor _Signature Date Robert Hussey, S. Cah Committee Member Signagyre Arik Levinson 2+ đa ` “aja|e® LẺ 2n, GC wby / 6, 22 z M.
Daniel Westbrook ˆ ⁄⁄ Director of Graduate Studies Signatufe Date f 7 This dissertation has been accepted by the Graduate School of Arts and Sciences. For the Dean THE EFFECTS OF MACROECONOMIC UNCERTAINTY ON IRREVERSIBLE INVESTMENT Ayse E. Thesis Advisor: Susan M. ABSTRACT I study the effects of demand and supply uncertainty on irreversible investment.
My objective is two fold. First, I investigate whether demand and supply uncertainty have similar effects on investment. Second, I study the effects of sunk costs on investment. I make three contributions to the existing literature.
First, I develop a methodology for analyzing the effects of demand and supply uncertainty on the level of investment where sunk costs interact with the both uncertainty measures in the estimation equation. Second, I explore the extent to which the uncertainty-investment relationship is affected by the magnitude of sunk costs. Third, I address the econometric issues raised by estimating a regression equation in which generated regressors appear. I use two different data sets in my empirical analyses.
In Chapters 1 and 2, I evaluate the effects of industry-wide uncertainty and sunk costs on the level of investment in 2-digit Turkish manufacturing industries. In Chapter 3, I investigate how demand and supply uncertainty, and sunk costs affect the aggregate manufacturing investment in thirteen OECD countries. In Chapters 1 and 2, I find that the effect of supply uncertainty on investment is negative in full sample estimates and in the sample of industries where demand is price elastic. The estimated impact, however, is positive in the sample of industries where demand is price ili inelastic.
I also find that investment is negatively associated both with sunk costs and the demand uncertainty. In Chapter 3, I find that the negative quantitative impact of the demand uncertainty on investment is larger than the impact of the supply uncertainty measure and that the estimated effects of the sunk cost proxy and the demand uncertainty measure are negative and statistically significant. The results suggest that the methodology provides quite a good fit for the data on the OECD countries. Therefore, the empirical results suggest that interaction variables are key im studying sign of the uncertainty-investment relationship.
These empirical findings could have important implications for countries. They suggest that policy makers should take into consideration the interactions between different types of uncertainty and sunk costs. iv Acknowledgments I would like to thank Prof. Collins for her support and guidance throughout this research.
She was always encouraging and considerate. She helped me overcome all the difficulties I had during my research. I am especially grateful to my committee members. Their supervision was enjoyable and ultimately informative.
I would like to thank Prof. for his diligent efforts in reviewing my work and for his thoughtful comments and suggestions. I would also like to thank Prof. Arik Levinson for his invaluable comments and for the interesting discussions.
Last but not least, my innermost appreciation is to my family- my parents Aydan and Halit, and my husband Ihsan. My parents provided me with the support, understanding, and motivation I almost always needed throughout this journey. They have been always standing by me, with their unconditional love and cheerful spirit. As for my husband, I am thankful for him for his invaluable help, continuous moral support, and distinct understanding.
I owe a lot to you all, Thank you. Dedication I dedicate this dissertation to my grandmother, Muyesser Turkmenoglu and to my uncle, Osman Turkmenoglu, both of whom passed away during the course of this research. I miss you both dearly. vi Table of Contents Tntroduction.
cece ence cece cnc e. weal Chapter 1: The Impact of Macroeconomic Uncertainty and Sunk Costs on Investment.2: LLICTATUT€ TC VI Âu. nu nh cà ¬— ¬— 7 I9: 23v-i x16: 2; hen. ¬ EERE EE EEE D EEE EE EE ESE EEE S EEE ea E DEEL EE EE ES 16 1.5: Data and preliminary SfatISHCS.
cu cv và. 25 Chapter 2: Macroeconomic Uncertainty, Sunk Costs, and Investment: Time-Series and Cross-Sectional Evidence From Turkish Manufacturing. ¬ ¬ kh hai KH xi weaned? 2. ccc nu nhe hà.
¬ dc HH ng HH nh K ky ng Ki tt mi kh và 37 2.3: Theoretical model and methodOÌOĐV. cuc LH nh TH nh nh kh ha Al 2.4: Data and preliminary "1 ST .5: Estimation r€SUÌfS. so tt Hà HT HN Ko ng vớ 49 2. E EEE E ANNE PEPE ERA EEE E EES RAPE SRE EEE EES SS 54 Chapter 3: Macroeconomic Uncertainty, Sunk Costs, and Aggregate Investment: Emprrical Evidence From the OECÐ Countries.
" ¬ ¬ HH nà kh na 63 3. cuc cv cuc.2: LI€TAfUT€ T€VICW,. Cenc bene etree ent Eee eset arene nce tae ESn ete eee ESS 64 3.3: Theoretical model and methodology. errr eee errr re ,,69 vũ 3.4: Data and preliminary SIAaEISEHCS.
HHnh Y kh nà tk nh yKr 74 Kho. nh hố eeắằắẮắẮe. S4 Appendix A: Data description and sources for Chapt€T Ï. con chen s 95 Appendix B: Computation of coefficients and standard errors for marginal effects in (IEì))- vlttttiiiiiiiiiiii.
98 Appendix C: Theoretical model for Chap{€T 2. cuc nh HH Y KH nh on xa 99 Appendix D: Data description and sources for Chapt€T 2. nh HH nhàn này 101 Appendix E: Specification tests for the uncertainty measures in Chapter 2. 103 Appendix F: Correction method for generaf€d TCBTCSSOTS,.
cuc nhàn nh kh hào 105 Appendix G: Data description and sources for Chapf€T 3. Hs khen nhàn 109 Appendix H: SpecIfication tests for the uncertainty measures Chapter 3. 111 Appendix k Summary of existing literature on sunk cost proxies. EES EE ED 114 List of Figures Figure 1: Real GDP Growth Rates (percenf) in Turkey, (1970-2000).
cuc eee 27 Figure 2: Annual Inflaton, WPI (percenf) m Turkey, (1970-2000). che ào 27 Figure 3: Investmert in Ageregate Manufacturing m Turkey, (1970-2000). 28 Figure 4: Real Exchange Rate Index in Turkey, (1980-2000). 28 List of Tables Table 1: Descriptive statistics on investment in sixteen Turkish manufacturing INGUSTHIES.
00 cece een nen E EE DE EEE EEE E ERE E EEDA ONES EEE OLE EEE ORES AE EDD EGER EEEE REEDS 29 Table 2: Descriptive statistics on the supply and demand uncertainty measures vill and sunk cost measure across sixteen Turkish manufacturtng InduSfri€S. 30 Table 3: Descriptive statistics on the supply and demand uncertainty measures across sixteen Turkish manufacturing IỎUSETICS. uc vác LH nh ki kh 31 Table 4: Panel estimation results for the investment-value added ratio as a function of uncertainty measures, sunk COs{ me€asure, and OUfDUÍ. „uc cán vn nh nh nh 32 Table 5: Net effects of change in the sunk cost measure, demand uncertainty measure, and supply uncertainty measure on the investment-value added ratio.ccc eee ece eee re eee caes 33 Table 6: Panel estimation results for the investment-value added ratio as a function of uncertainty measure, sunk cost measure, and output in industry gTOUDS.
34 Table 7: Net effects of change in the sunk cost measure, demand uncertainty measure, and supply uncertainty measure on the investment-value added ratio in industry groups.35 Table 8: Descriptive statistics on labor productivity and inventory series in sixteen Turkish Manufacturing IMCUStrieS. 57 Table 9: Descriptive statistics on the demand and supply uncertainty measures and sunk cost measure in sixteen Turkish manufacturing I1dUSẨT1CS. 58 Table 10: Panel estimation results for the investment-value added ratio as a function of uncertainty measures, sunk cost €aSUT€, 1d OU[DUÍ. uc ng n nen ch hư nh he ra 59 Table 11: Net effects of change in the sunk cost measure, demand uncertainty measure, and supply unccrtainfy measure ơn the investmenf-value added ralio.
60 Table 12: Panel estimation results for the investment-value added ratio as a function of the uncertainty measures, sunk cost measure, and output in induSfrV ðTOUDS. 61 Table 13: Net effects of change in the sunk cost measure, demand uncertainty measure, and supply uncertainty measure on the investment-value added ratio in elastic and inelastic industry 1X Table 14: Aggregate empirical studies on the sign of uncertainty-investment relationship.87 Table 15: Disaggregate empirical studies on the sign of uncertainty-investment relationship.89 Table 16: Effects of different uncertainty measures that are used in empirical analyses in Tables 14 and 15. 90 Table 17: Descriptive statistics on investment and output in aggregate manufacturing in thirteen 9)5098. 9] Table 18: Descriptive statistics on the demand and supply uncertainty measures and the sunk cost proxy in thirteen OECD Countries.cccc cee cce ete rec eee e eee rennet eee Sena Pepe sneer eee teeees 92 Table 19: Panel estimation results for the investment-value added ratio as a function of uncertainty measures, sunk cost proxy and output in thirteen OECD countries.
93 Table 20: Net effects of change in the sunk cost proxy, demand uncertainty measure, and supply uncertainty measure on the investment-value added ratio in thirteen OECD countries.94 Introduction Given the importance of investment for a nation’s economic performance, it comes as no surprise that analysis of investment remains a subject of key theoretical and empirical concern to economists. Within the broad corpus of work on investment, the real options approach to investment literature focuses on how uncertainty affects investment when investment expenditures are irreversible and when there is uncertainty over the future returns from the investment. The theoretical work in this literature shows that greater uncertainty may have a negative or a positive impact on irreversible investment depending on the choice of parameters of the underlying model. Although most empirical work finds a negative association between uncertainty and investment, empirical results are far from establishing a consensus about the sign of the uncertainty-investment relationship.
In this work, I utilize a theoretical framework from the real options approach to investment literature to study the effects of demand and supply uncertainty on the level of investment. L investigate whether or not demand and supply uncertainty have similar effects on investment. I also study the extent to which the uncertainty-investment relationship is affected by sunk costs. I make three contributions to the existing literature.
First, I develop and implement a methodology for analyzing the effects of both demand and supply uncertainty on the level of investment.
