Interest Rate Uncertainty and Tobin’s Q: Nontrivial Impacts of Anticipated Regime Changes – Valtteri Peltonen (Department of Accounting and Finance)

In this paper, we study how an anticipated regime change in interest rates affects firms’ investment decisions. To this end, we built a stylized theoretical model, in the spirit of the neo-classical theory of investment, that allows for semi-explicit expressions for the relevant quantities. Our results show that neither the current interest rate regime nor the long-term stationary equilibrium of the economy is sufficient to pin down the optimal investment prior to the switch, thereby questioning the constant interest rate assumption in traditional investment models. We mainly contribute to the literature on the relationship between uncertainty and investment. Our model shows how anticipation of a structural break can significantly affect the level of optimal investment and, consequently, suggests that this forms an important source of uncertainty in firm decision-making—alongside, for example, interest rate and factor price volatility.