Uncertainty in competing models of investment: evidence from the USA

Abstract

As explained in Chapter 8, Tobin’s q models of investment are founded on the assumption that Stock Market valuations will provide information about the likely future prospects of firms. This approach revolves around an efficient markets assumption: that share prices fully reflect all available information about the likely future prospects of firms and so rational investors can look to the Stock Market in assessing the potential future value of investments. As explained in Chapter 9, the influence of uncertainty is generally captured in orthodox analysis by super-imposing uncertainty variables on top of q models. Keynes and Post Keynesian analysts also argue that the Stock Market will influence investment but Post Keynesian analyses tend to focus on the role of speculative activity as a destabilizing force that exacerbates uncertainty. As discussed in Chapter 8, the real options theorists have confirmed empirically the hypothesis that uncertainty will depress investment but this negative correlation is also consistent with Post Keynesian theory. In other words, the finding of this negative relationship does not in itself provide evidence about the relative merits of competing investment theories.