INVESTMENT UNDER UNCERTAIN MARKET CONDITIONS

This paper studies the responsiveness of firm investment to shocks in the input factor and output prices (the market conditions) by using st ock market information on excess returns. The q theory of investment i s modified to allow for heterogeneous capital, ex post inflexible tech nology, and irreversible investment. A structural model linking the ex cess returns to a firm's equity to the firm's investment history and t he evolution of the market conditions is estimated using a panel of U. S. manufacturing firms. The estimates of the cost of adjusting the cap ital stock are economically sensible. They imply a high degree of sens itivity of investment to fundamental variables that affect the profita bility of capital such as the market conditions and the purchase price of capital.