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

From Ryan Kellogg:

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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About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar. http://faculty.chicagobooth.edu/owen.zidar/index.html
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