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Empirical Economics

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20-01-2021

Economic disasters and aggregate investment

Authors: Bruno Ćorić, Vladimir Šimić

Published in: Empirical Economics | Issue 6/2021

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Abstract

The 2007–2008 global financial crisis has spurred an increasing interest for investigating the financial and macroeconomic effects of the rare but extremely large economic crises, the so-called economic disasters. Current literature on the topic shows that probability of economic disasters plays an important role in the long-run effect of output volatility on investment. This paper investigates the long-run relationship between economic disasters and aggregate investment. We analyze the data for a large number of developing and developed countries after the World War II. The conducted panel data analysis indicates a negative effect of the probability of economic disasters on aggregate investment. Our results contribute to the recent literature on economic disasters by providing empirical support for the hypothesis that probability of infrequent but extremely large economic crises has a negative long-run effect on investment. We also find that the effect of ‘normal’ output volatility on aggregate investment is relatively small.

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See Priesmeier and Stahler (2011) for the review of this literature.

Note that the potential short-run effect of uncertainty on investment has been studied extensively. A large body of literature focuses on ‘real options’ (Bernanke 1983; Pindyck 1991; Bloom 2009), that is, on the idea that under irreversibility of investment firms that face an increase in uncertainty may prefer to wait and delay their investment until uncertainty is resolved. The short list of the recent researches in this literature include: Bloom et al. (2007), Panousi and Papanikolaou (2012), Bachmann et al. (2013), Glover and Levine (2015), Buchholz et al. (2016) and Meinen and Roehe (2017). For a detailed overview of the literature on uncertainty and the relationship between uncertainty and investment see Carruth et al. (2000) and Bloom (2014).

The equity premium puzzle refers to the finding that the standard consumption-based asset-pricing models cannot explain the amount of the excess real return on stocks relative to the return on government bills assuming reasonable levels of risk aversion (Mehra and Prescott 1985).

See Tsai and Wachter (2015) for a survey of the economic disasters models.

1960–1964; 1965–1969; 1970–1974; 1975–1979; 1980–1984; 1985–1989; 1990–1994; 1995–1999; 2000–2004; 2005–2009; 2010–2014; 2015–2018.

With respect to the gaps in the data, the following general principle is adopted. In the country periods where one observation for a certain variable is missing, the value of that variable is still calculated. In the cases where more than one observation is missing, the country period is excluded from the analysis.

Given that the rate of depreciation is assumed to be constant across countries, adjustment of output growth for depreciation becomes trivial.

1950–1979; 1955–1984; 1960–1989; 1965–1994; 1970–1999; 1975–2004; 1980–2009; 1985–2014.

The data are available up to 2009 while country starting dates vary, ranging from 1790 for the United States to 1911 for Korea and South Africa.

Please note that our organization of the data on economic disasters into the overlapping periods also does not work in favor of our empirical estimates of the hypothesized negative effect on investment, because it smooths out the within-country variations in our main explanatory variable.

The method is implemented by using the ivregh2 Stata module which allows application of the Lewbel’s (2012) estimator in panel data regressions (Baum and Lwebel 2020).

Since the Cragg-Donald Wald F statistic is not robust to heteroscedasticity Baum et al. (2007) suggest reporting the Kleibergen-Paap rk Wald F statistic for the weak identification when i.i.d. residuals are not assumed. Because the Stock and Yogo’s (2005) tabulated critical values are calculated for the case of i.i.d. residuals, they also suggest application of the older “rule of thumb” indicating that the F statistic should be at least 10 for weak identification not to be considered as a problem.

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Title: Economic disasters and aggregate investment
Authors: Bruno Ćorić
Vladimir Šimić
Publication date: 20-01-2021
Publisher: Springer Berlin Heidelberg
Published in: Empirical Economics / Issue 6/2021
Print ISSN: 0377-7332
Electronic ISSN: 1435-8921
DOI: https://doi.org/10.1007/s00181-020-02010-2

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