“Corporate Investment Over Uncertain Business Cycles” by Youchang Wu
University of Wisconsin, Madison
Vienna University of Technology
We present a dynamic model of irreversible corporate investment over the business cycle with uncertainty about the true state of the economy. We show that the firm's optimal investment threshold, defined by the ratio of the current demand factor to the capital stock, is a concave function of the firm's posterior probability of being in an expansion. Our model replicates some important features of the capital growth rate empirically observed. Despite the strong positive skewness of capital growth rate at the firm level, the average capital growth rate across firms, as well as its first-order difference, exhibits a negative skewness. The sharp-decline-slow- recovery feature of the average capital growth rate is due to both the concavity of the investment boundary and the distribution of firms relative to the boundary, which together cause firms in aggregate to react more strongly to bad signals in good times than to good signals in bad times.