American Economic Review: Vol. 104 No. 6 (June 2014)

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

Article Citation

Kellogg, Ryan. 2014. "The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling." American Economic Review, 104(6): 1698-1734.

DOI: 10.1257/aer.104.6.1698

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: (1) the response of drilling activity to changes in price volatility has a magnitude consistent with the optimal response prescribed by theory, (2) the cost of failing to respond to volatility shocks is economically significant, and (3) 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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Online Appendix (361.20 KB) | Download Data Set (664.95 KB) | Author Disclosure Statement(s) (69.57 KB)

Authors

Kellogg, Ryan (U MI)

JEL Classifications

C58: Financial Econometrics
D92: Intertemporal Firm Choice: Investment, Capacity, and Financing
G13: Contingent Pricing; Futures Pricing; option pricing
G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
L71: Mining, Extraction, and Refining: Hydrocarbon Fuels
Q31: Nonrenewable Resources and Conservation: Demand and Supply; Prices


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