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Can real options explain the impact of uncertainty on Chinese corporate investment?

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  • He, Ye
  • Hu, Weiping
  • Li, Kunwang
  • Zhang, Xiao

Abstract

The real options theory suggests that firms with high uncertainty would not invest unless investment opportunities are high. However, using the industrial census of manufacturing firms in China over the period 1998–2013, we find that firms do not invest aggressively even if investment opportunities are high. To investigate why Chinese firms do not sensitively respond to high investment opportunities, we develop a dynamic model including a sentiment channel. When managers are less confident about their business prospects, managers make investment decisions with worst-case beliefs which prevent investment from responding sensitively to high investment opportunities especially when uncertainty is high. The empirical results confirm our theoretical predictions. Moreover, the impact of uncertainty is more pronounced during the 2008 Global Financial Crisis, reflecting further the role of sentiment to uncertainty in firm investment decisions. Our results are robust to using different measures of uncertainty and estimation methods.

Suggested Citation

  • He, Ye & Hu, Weiping & Li, Kunwang & Zhang, Xiao, 2022. "Can real options explain the impact of uncertainty on Chinese corporate investment?," Economic Modelling, Elsevier, vol. 115(C).
    • Handle: RePEc:eee:ecmode:v:115:y:2022:i:c:s0264999322001730
    DOI: 10.1016/j.econmod.2022.105927
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