The high cost of capital for firms conducting medical research and development (R&D) has been partly attributed to the government risk facing investors in medical innovation. This risk slows down medical innovation because investors must be compensated for it. We propose new and simple financial instruments, Food and Drug Administration (FDA) hedges, to allow medical R&D investors to better share the pipeline risk associated with FDA approval with broader capital markets.
G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
Micro- and macro-level evidence indicates that fluctuations in idiosyncratic uncertainty have a large effect on investment; the impact of uncertainty on investment occurs primarily through changes in credit spreads; and innovations in credit spreads have a strong effect on investment, irrespective of the level of uncertainty. These findings raise a question regarding the economic significance of the traditional “wait-and-see” effect of uncertainty shocks and point to financial distortions as the main mechanism through which fluctuations in uncertainty affect macroeconomic outcomes.
Using the Baker, Bloom, and Davis (2013) news-based measure to capture economic policy uncertainty (EPU) in the United States, we find that when EPU increases by 1%, contemporaneous market returns fall by 5.5% and economy-wide monthly implied cost of equity capital rises by 85 basis points. The economy-wide dividend yield rises as well. We attribute the market-wide price decline to discount rate shocks, as dividends are unaffected for up to two years.
Government policy uncertainty has a dampening effect on foreign direct investment (FDI) around the world. Using the timing of national elections as a measure of exogenous ﬂuctuations in policy uncertainty, we ﬁnd that FDI ﬂows from US companies to foreign afﬁliates drop signiﬁcantly during election periods. The patterns in FDI ﬂows are more pronounced in countries with higher propensities for policy reversals and when election outcomes are more uncertain.