Investment, financial markets, and uncertainty

This paper provides a theoretical explanation of the accumulation process, which accounts for the developments in the financial markets over the recent past. Specifically, our approach is focused on the presence of correlations between physical and financial investment, and how the latter could affect the former. In order to achieve this objective, two assets are considered: equities and bonds. This choice permits us to account for two extreme alternative possibilities: taking risk in the short run with unknown profits, or undertaking a commitment to the long run with known yields. This proposal also accounts for the influence of the cost of external finance and the impact of financial uncertainty, as proxied by the interest rate in the former case and the exchange rate in the latter case; thereby utilizing the Keynesian notion of conventions in the determination of investment. The model thus formulated is subsequently estimated by applying the difference GMM and the system GMM in a panel of 14 OECD countries from 1970 to 2010.