The Effect of Risk on Investment: New Evidence

Abstract

Previous results on the relation between risk and investment are mixed, partly due to endogeneity. To allievate the effects of this bias, we adopt a generalized method of moments (GMM) dynamic panel estimator to investigate the relation. We find that the puzzling positive sensitivity of investment (i.e. firm’s investment rate) to systematic risk as frequently documented in previous studies disappears. Further, we show that the more irreversible the firm’s investments are, the more valuable is the option to delay investment when risk is high, which supports the model with irreversible investment.