Working Paper: NBER ID: w16541
Authors: Ryan Kellogg
Abstract: Despite widespread application of real options theory in the literature, the extent to which firms actually delay irreversible investments following an increase in the uncertainty of their environment is not empirically well-known. This paper estimates firms' responsiveness to changes in uncertainty using detailed data on oil well drilling in Texas and expectations of future oil price volatility derived from the NYMEX futures options market. Using a dynamic model of firms' investment problem, I find that oil companies respond to changes in expected price volatility by adjusting their drilling activity by a magnitude consistent with the optimal response prescribed by theory.
Keywords: Investment; Uncertainty; Oil Drilling; Real Options Theory
JEL Codes: D21; D81; E22; L21; L71; Q41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expected oil price volatility (Q47) | drilling activity (L71) |
| expected future price of oil (Q47) | drilling activity (L71) |
| implied volatility from futures options (G13) | drilling activity (L71) |
| historical price volatility (N21) | drilling activity (L71) |