PurposeThe objective of this paper is threefold. First, it aims to empirically study whether firm-specific/idiosyncratic uncertainty, macroeconomic/aggregate uncertainty and political uncertainty have an adverse influence on firms' investment decisions in Pakistan. After establishing this, it scrutinizes whether the uncertainty effects on investment are different for firms of different sizes. Finally, it investigates whether any heterogeneity exists in the uncertainty impacts across different industries.Design/methodology/approachThe empirical analysis is based on an unbalanced panel data of 468 nonfinancial firms listed at the Pakistan Stock Exchange (PSX) during the period 2000–2018. Departing from the literature, the paper builds a time-varying composite volatility/uncertainty index based on the principal component analysis (PCA) by utilizing the constructed volatility series for sales, cash flows and return on assets to gauge firm-specific uncertainty for each firm included in the analysis. Likewise, the paper develops a PCA-based composite index for macroeconomic uncertainty by using the conditional variance series of consumer price index (CPI), industrial production index (IPI), the interest rate and the exchange rate obtained by estimating the (generalized) autoregressive conditional heteroscedastic, (G)ARCH, models. Finally, political uncertainty is measured by political risk components maintained by the Political Risk Services Group. The empirical framework of the paper augments the standard investment equation by incorporating all three types of uncertainty. Firms are grouped into small, medium and large categories based on firms' total assets and the size indicators are generated. Next, the indicators are multiplied by each uncertainty measure to quantify the differential effects of uncertainty across firm size. Firms are also differentiated by sectors to explore the sector-based asymmetries in the uncertainty effects. The “robust two-step system generalized method of moments (2SYS GMM) (dynamic panel data) estimator” is applied to estimate the empirical models.FindingsThe results provide robust and strong evidence of the detrimental influence of all three types of uncertainty on investment. Yet, it is observed that the strength of the influence considerably varies across uncertainty types. In particular, compared to firm-specific uncertainty, both macroeconomic and political uncertainties have more unfavorable effects. The analysis also reveals that the effects of all three types of uncertainty are quite different at small, medium and large firms. Specifically, it is observed that although the investment of all firms is influenced adversely by magnified uncertainty, the adverse effects of all three kinds of uncertainty are quite stronger at small firms than medium and large firms. These findings support the phenomenon of size-based asymmetries in the effects of uncertainty on investment. The results also provide evidence that either type of uncertainty quite differently affects the investment policy of firms in different sectors.Practical implicationsThe findings help different stakeholders to know how different types of uncertainty differently affect corporate firms' investments. Further, they suggest that firm size has a vital role in ascertaining the adverse effects of uncertainty on investment. The paper identifies to which type of uncertainty investors and policymakers should care more about and to which types of firms and industries they should concern more during volatile times. Firms should have more fixed assets and expand their size to mitigate the detrimental effects on investment of internal and external uncertainties. The government should enhance the political stability to induce firms for a higher level of investment, which, in turn, will result in higher growth of the economy.Originality/valueThe originality of the paper is credited to four aspects. First, unlike most previous studies that have utilized a single volatility measure, this paper constructs composite uncertainty indices based on the weights determined by the PCA. Second, it examines the effect of political uncertainty over and above the effects of idiosyncratic and aggregate (macroeconomic uncertainty) for an emerging economy. Third, and most important, it provides first-hand empirical evidence on the role of firm size in establishing the asymmetric effects of uncertainty on investment. Finally, it provides evidence on the industry-based heterogeneity in the uncertainty effects.

The uncertainty–investment relationship: scrutinizing the role of firm size

The deep integration of information technology (IT) and the real economy contributes to China’s high-quality economic sustainable development From the perspective of efficiency, this paper aims to build an evaluation index system, with 30 provinces in China from 2011 to 2017 being taken as the research objects, conduct static and dynamic analysis by using the super-efficiency data envelopment analysis (DEA)-Malmquist index, and draw a spatial distribution diagram to reflect its changes This study reveals that the integrated development of information technology and the real economy is unbalanced in China The eastern region performs better with a development slowdown, while the central and western regions lag behind with a lot of room for improvement The effect of regional agglomeration is obvious, which can be evidenced by the fact that those provinces with a high-efficiency value produce a radiation effect on their neighboring provinces On the whole, the total factor productivity is increasing annually, with the technical progress being the main factor that affects the total efficiency According to the results, the countermeasures and suggestions are put forward in this paper to provide reference for a better sustainability development of information technology and the real economy

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Integrated Development of Information Technology and the Real Economy in China Based on Provincial Panel Data

For the euro area as a whole, gross domestic fixed capital formation rose by 4.2% in 1998, compared with an increase of around 2% in the previous year. The contribution of investment to real GDP growth rose to 0.8 percentage point in 1998, compared with 0.4 percentage point in 1997. This was the strongest contribution to growth since 1990 and, in conjunction with robust private consumption, it underpinned the overall acceleration in output growth observed last year. However, viewed from a more medium-term perspective, the rise in investment has been relatively subdued for a number of years and it may be regarded as somewhat surprising that investment growth has not responded more strongly to the upturn in activity that has taken place from mid-1995 onwards. Indeed, it appears that, since peaking at around 22% in the early 1990s, the ratio of investment to GDP has fallen significantly, to around 18.5% during 1998 (see the chart below). The ratio of investment to GDP is calculated on the basis of current prices. However, as the relative price of investment goods has tended to fall, the development of investment has been slightly more positive when measured in terms of constant prices. This relative price decline is at least partly due to the strong downward trend in the prices of many high technology investments, such as personal computers and computer software.

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Investment in the Euro Area

Motivated by the fact that uncertainty shocks are a countercyclical phenomenon, this article takes a deeper look at the nature of uncertainty shocks in times of crisis and its effect on the real ec...

Real options or disaster risk? Distinguishing uncertainty effects on investment

This paper studies the aggregate implications of microeconomic investment irreversibility and idiosyncratic uncertainty in a simple growth model by highlighting real option effects. We endogenize the drift rate of real option by connecting it to the state of the economy. Thereby, we extend the analysis of the optimal capital accumulation policy in the firm sector and show the different implications of idiosyncratic and aggregate uncertainty on growth dynamics.

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Hanno Dihle

Papers

Real options or disaster risk? Distinguishing uncertainty effects on investment

Real Options in a Ramsey style Growth Model