Investment, uncertainty and pre-emption
AbstractThis paper examines irreversible investment in a project with uncertain returns, when there is an advantage to being the first to invest and externalities to investing when others also do so. We show that the possibility of pre-emption can have significant qualitative and quantitative effects on the relationship between uncertainty and investment. In a single-agent real options model, the trigger threshold for investment increases without bound as uncertainty grows. In contrast, the investment trigger of a leader faced with pre-emption is bounded above as uncertainty increases. In fact, we show that under certain parameter values, greater uncertainty can lead the leader to invest earlier. These findings reinforce the importance of extending real options analysis to include strategic interactions between players. Applications to industry situations are also discussed.
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Bibliographic InfoArticle provided by Elsevier in its journal International Journal of Industrial Organization.
Volume (Year): 28 (2010)
Issue (Month): 3 (May)
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Web page: http://www.elsevier.com/locate/inca/505551
Real options Investment valuation Uncertainty Pre-emption;
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