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Impact of Bayesian Learning and Externalities on Strategic Investment

Author

Listed:
  • H. Dharma Kwon

    (Department of Business Administration, University of Illinois at Urbana–Champaign, Champaign, Illinois 61820)

  • Wenxin Xu

    (Department of Business Administration, University of Illinois at Urbana–Champaign, Champaign, Illinois 61820)

  • Anupam Agrawal

    (Mays Business School, Texas A&M University, College Station, Texas 77843)

  • Suresh Muthulingam

    (Smeal College of Business, The Pennsylvania State University, University Park, Pennsylvania 16802)

Abstract

We investigate the interplay between learning effects and externalities in the problem of competitive investments with uncertain returns. We examine a game theoretic duopoly investment model in which (i) a firm can learn about the profitability of the investment by observing the performance of the first mover and (ii) externalities exist between the investments of two firms. We find a region of a war of attrition between the two firms in which the interplay between externalities and learning gives rise to counterintuitive effects on investment strategies and payoffs. In particular, we find that, contrary to the conventional war of attrition where an increase in benefits for the follower generally delays the first move, an increase in the rate of learning—which tends to benefit the follower—can hasten the first investment. This paper was accepted by James Smith, decision analysis.

Suggested Citation

  • H. Dharma Kwon & Wenxin Xu & Anupam Agrawal & Suresh Muthulingam, 2016. "Impact of Bayesian Learning and Externalities on Strategic Investment," Management Science, INFORMS, vol. 62(2), pages 550-570, February.
    • Handle: RePEc:inm:ormnsc:v:62:y:2016:i:2:p:550-570
    DOI: 10.1287/mnsc.2015.2156
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    References listed on IDEAS

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    Cited by:

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    3. Sebastian Sund & Lars H. Sendstad & Jacco J. J. Thijssen, 2022. "Kalman filter approach to real options with active learning," Computational Management Science, Springer, vol. 19(3), pages 457-490, July.
    4. Steg, Jan-Henrik & Thijssen, Jacco J.J., 2023. "Strategic investment with positive externalities," Games and Economic Behavior, Elsevier, vol. 138(C), pages 1-21.
    5. Lu Xiao & Hang Zhang & Yong Qin, 2020. "Competitive Pricing of Innovative Products with Consumers’ Social Learning," Sustainability, MDPI, vol. 12(9), pages 1-13, May.
    6. Margaria, Chiara, 2020. "Learning and payoff externalities in an investment game," Games and Economic Behavior, Elsevier, vol. 119(C), pages 234-250.
    7. Zhang, Wenlong & Wang, Haijun, 2021. "Entrepreneurial decisions with idiosyncratic risk and unknown profitability," Economic Modelling, Elsevier, vol. 103(C).

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