The effects of uncertainty on investment and the expected long-run capital stock

This paper examines the effects of output price uncertainty on the optimal investment behavior of a risk-neutral competitive firm with a constant returns to scale production function. In the presence of convex costs of adjustment, investment is an increasing function of q, the shadow price of capital. Given the current price of output, we find that increased uncertainty will raise the current rate of investment. Increased uncertainty will also increase the expected long-run capital stock if the price of output is serially uncorrelated. However, if the price of output is serially correlated, then the direction of the effect of increased uncertainty on the expected long-run capital stock depends on the curvature of the marginal adjustment cost function. In this case, we obtain results which are directly opposite of the results in the literature and we locate the flaw in the existing analysis.