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Publication
Oil volatility and the option value of waiting : an analysis of the G-7
2009-08, Bredin, Donal, Elder, John, Fountas, Stilianos
There has recently been considerable interest in the potential adverse effects associated with
excessive uncertainty in energy futures markets. Theoretical models of investment under uncertainty
predict that increased uncertainty will tend to induce firms to delay investment. These models are
widely utilized in capital budgeting decisions, particularly in the energy sector. There is relatively
little empirical evidence, however, on whether such channels have industry-wide effects. Using a
sample of G7 countries we examine whether uncertainty about a prominent commodity – oil – affects
the time series variation in manufacturing activity. Our primary result is consistent with the
predictions of real options theory – uncertainty about oil prices has had a negative and significant
effect on manufacturing activity in Canada, France, UK and US.