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  3. American Economic Review
  4. June 2014
  5. The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling

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

  • Ryan Kellogg
American Economic Review
vol. 104, no. 6, June 2014
(pp. 1698-1734)
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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.

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

Additional Materials

JEL Classification

  • C58 Financial Econometrics
  • D25 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