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Idiosyncratic and common shocks to investment decisions

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This Paper shows how microeconomic data on investment plans can be used to study the structure of risk faced by firms. Revisions of investment plans form a martingale, and thus reveal the underlying shocks driving investment. We decompose revisions in investment plans into micro, sector and aggregate shocks, and exploit stock market data to distinguish between structural (valuerelated) shocks and measurement error in investment revisions. Using panel data for US firms, we find that microshocks are not the dominant source of risk in investment decisions, and that much of the observed microvariation is actually due to heterogeneity in firm-level responses to aggregate shocks. Firms are able to diversify most idiosyncratic investment risk, and they do not appear to be liquidity constrained.

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