In this paper we derive a model of aggregate investment that builds from the lumpy
microeconomic behavior of firms facing stochastic fixed adjustment costs. Instead
of the standard sharp (S,s) bands, firms' adjustment policies take the form of a
probability of adjustment (adjustment hazard) that responds smoothly to changes in
firms' capacity gap. The model has appealing aggregation properties, and yields nonlinear
aggregate time series processes. The passivity of normal times is, occasionally,
more than offset by the brisk response to large accumulated shocks. Using within
and out-of-sample criteria, we find that the model performs substantially better
than the standard linear models of investment for postwar sectoral U.S. manufacturing
equipment and structures investment data.
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