EMPIRICAL STUDIES ON THE NEOCLASSICAL (PHYSICAL) INVESTMENT MODEL

Abstract

Asymmetric Information in credit markets drives a wedge between external and internal costs of funds. As a result, investment may depend on the availability of internal funds. This paper tests this hypothesis by estimating a reduced form equation using firm level data from Singapore. The empirical results strongly suggest that internal funds have effects on inventory investment in the period 1984-1992. The linkage between inventory investment and internal funds is found to be stronger during the recession period. The findings are consistent with the view that: 1) credit market frictions have important impacts on investment spending; 2) the "balance sheet" channel is likely to be particularly important in explaining inventory fluctuations during downturns.