Testing Real Options Theory Using Data on Capital Adequacy

Abstract

This paper uses unique survey-based data that record the extent of positive and negative disequibrium in capital stock at industry level. We observe movement in this disequilibrium and model it to take account of long-run plans, short-term revisions to expectations, and the influence of uncertainty on adjustment. We find that increased uncertainty slows the adjustment of fixed capital towards equilibrium levels, in line with the predictions of real options theory and partial irreversibility models.