Q-Tobin and investments

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RESEARCH PROJECT

Q-Tobin and investments

Ryskalieva Madina, marketing

University of International Business

                                                     Almaty, 2023

Q-Tobin and investments

INTRODUCTION

  Neoclassical and James Tobin's theory (also known as the Q-theory) are the two basic investing theories.

According to the neoclassical theory of investment, a firm's need for capital depends on a number of external factors, and decisions regarding investments are made with the goal of optimizing net discounted cash flow. However, there are issues with this hypothesis. As a result, a sudden change in an exogenous variable may cause a sudden shift in the quantity of capital. Additionally, the early version of neoclassical theory does not account for agents' expectations.

Neoclassical investment theory was modified as the next phase in the evolution of investment theory (authors: Lucas, Gold, and others). The model has been amended to include the internal costs of capital oversight, such as those associated with staff training and equipment installation. Thus, rather of controlling the total amount of capital, this approach allowed businesses to control the pace of investment in each quarter.

The term Q, or the ratio of the market value of a business to its replacements value, is a key component in J. Tobin's theory. If the project's market price is more than its costs (Q > 1), the company will invest money in it. Additionally, this theory is predicated on the internal expenses of capital control; otherwise, the business might regulate its level (lower or increase it), bringing Q to one, which is impractical given the constraints of a constrained investment rate among firms.

Q's two key ideas have been identified:

The market value to replacement value ratio of an additional capital unit is known as the marginal Q.

The market value of the company's existing capital to its replacement value is referred to as the average (average) Q.

Depending on the underlying assumptions, the marginal and mean Q have distinct relationships.

LITERATURE REVIEW    

  The Q-theory, like any other theory, has benefits and drawbacks that are supported by application. The correlation between q-Tobin and investment has been studied, although the idea has also been rigorously challenged.

We'll begin by looking at some of the theory's qualitative features. There were 3 articles looked at:

1. Huntley Schaller “A re-examination of the Q theory of investment using US firm data” (1990);

2. Russel Cooper, Joao Ejarque “Exhuming Q: Market Power vs. Market Imperfection”(2001);

3. Stephen Oliner, Glenn Rudebusch, Daniel Sichel “New and Old Models of Business Investment: A Comparison of Forecasting Performance” (1995),

wherein the writers carried out research using the ideas of investment theory. The authors of each piece discussed the benefits and drawbacks of the Q-theory, provided their own study, and summarized the findings. The benefits of this idea shall be emphasized first.

The dynamic optimization of a corporation with convex regulation costs is the solution to the central problem of Q-theory. The company compares the future marginal profits with the current marginal price of investing. The ratio of the firm's worth to its share capital, or the average Q, can serve as a representation of this marginal advantage under specific conditions (essentially consistent limitations on profits and regulatory expenses). This method of calculating investment has visibility as its principal benefit, meaning that the average Q totals the anticipated discounted present value of the additional investment. The idea that current profit does not adequately explain current investment is also present. (Joao Ejarque, Russell Cooper)Questioning A: Market Power versus.

To name a few benefits of the Q-theory, the following must be mentioned:

Firstly, Q-Tobin's investment model is the only one that enables output to be an endogenously determined variable. Second, unlike other models (such as the neoclassical Jorgenson model), this one is based on changes in variables now rather than in the past. Finally, Q-theory dodges Lucas' criticism. (Huntley Schaller, "A re-examination of the Q theory of investment using US firm data"

Additionally, the Q-theory's drawbacks are taken into account, and details regarding the studies the publications' writers performed are provided.

According to Huntley Schaller's "A re-examination of the Q theory of investment using US firm data" (1990), theoretical predictions made by the Q-theory may not always line up with empirical findings. The results are as follows after multiple attempts to estimate investment equations based on Q-theory. Theoretically, investment and q are closely associated, yet the majority of research' findings do not support the Q-theory of investment.

Initial, variations in Q often only account for just a small percentage of variations in investment levels. Second, the unexplained portion typically exhibits a high degree of autocorrelation. Thirdly, the predicted cost of regulation is frequently so high that it appears to be economically unviable. Fourth, factors that the usual Q-theory predicts ought not to have an impact on investment really do (such as profits and output).

Thus, H. Schaller offers two arguments in his work for why the Q-theory's empirical findings are so insufficient: the aggregation issue and the futility of the assumption of perfect market competition.

To avoid the issue of aggregation, H. Schaller used data from each company in the study. Thus, information on 188 different companies was used. The findings of his study demonstrated that the issue of aggregation may be avoided when using data for single enterprises, and that the amount of autocorrelation will be far lesser than in studies using aggregated data. The high estimate of the level of marginal cost of regulation is also at least in part due to the aggregation problem. This study specifically challenged the idea that all businesses experience the same regulatory expenses. The outcomes for imperfect competition demonstrate significantly reduced internal costs of capital regulation.