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Investment, uncertainty and pre-emption

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Author Info

  • Mason, Robin
  • Weeds, Helen

Abstract

This 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 Info

Article provided by Elsevier in its journal International Journal of Industrial Organization.

Volume (Year): 28 (2010)
Issue (Month): 3 (May)
Pages: 278-287

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Handle: RePEc:eee:indorg:v:28:y:2010:i:3:p:278-287

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Web page: http://www.elsevier.com/locate/inca/505551

Related research

Keywords: Real options Investment valuation Uncertainty Pre-emption;

References

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  1. Eric Maskin & Jean Tirole, 2010. "A Theory of Dynamic Oligopoly, 1: Overview and Quantity Competition with Large Fixed Costs," Levine's Working Paper Archive 397, David K. Levine.
  2. repec:fth:tilbur:9992 is not listed on IDEAS
  3. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
  4. Boyer, Marcel & Lasserre, Pierre & Mariotti, Thomas & Moreaux, Michel, 2004. "Preemption and rent dissipation under price competition," International Journal of Industrial Organization, Elsevier, vol. 22(3), pages 309-328, March.
  5. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June.
  6. Grzegorz Pawlina & Peter M. Kort, 2006. "Real Options in an Asymmetric Duopoly: Who Benefits from Your Competitive Disadvantage?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 15(1), pages 1-35, 03.
  7. Dixit, Avinash, 1979. "The Role of Investment in Entry-Deterrence," The Warwick Economics Research Paper Series (TWERPS) 140, University of Warwick, Department of Economics.
  8. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  9. Nalin Kulatilaka & Enrico C. Perotti, 1998. "Strategic Growth Options," Management Science, INFORMS, vol. 44(8), pages 1021-1031, August.
  10. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June.
  11. Fudenberg, Drew & Tirole, Jean, 1986. "A Theory of Exit in Duopoly," Econometrica, Econometric Society, vol. 54(4), pages 943-60, July.
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