In Discussion Paper No. 1497, Luigi Guiso and Giuseppe Parigi use data on Italian manufacturing firms in 1993 drawn from the Survey on Investment in Manufacturing to investigate the effects of uncertainty on investment decisions. The subjective probability distribution of future demand for the firm's product reported in this survey allows the researchers to construct a measure of the uncertainty faced by each individual firm, which can be related to its investment decision.

The main findings are consistent with theoretical predictions of a negative relation between investment and uncertainty. It is also shown that this negative effect cannot be explained by uncertainty proxying for credit constraints, credit rationing being naturally more likely among riskier firms. The estimates also show, however, that there is considerable heterogeneity in the effect of uncertainty across groups of firms that differ in the degree of reversibility of investment decisions or in market power. At the same time they suggest that for firms facing a demand with high price elasticity and for those whose capital goods are relatively easy to resell if necessary, uncertainty is unlikely to be particularly important.

Investment and Demand Uncertainty
Luigi Guiso and Giuseppe Parigi