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The Present Value of Profits and Cyclical Movements in Investment

Andrew B. Abel
Olivier J. Blanchard

Abstract

Much of the empirical work on investment is based on the existence of a relation between investment and the expected present value of marginal profits. In this paper we compute such a present value series, under various assumptions about demand and technology, and examine its relation to investment. We find that variations in this present value series are, surprisingly, due more to variations in the cost of capital than to variations in marginal profit. We also find that the present value series, although significantly related to investment, still leaves unexplained a large, serially correlated fraction of the movement in investment.