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A Strategic R&D Investment with Flexible Development Time in Real Option Game Analysis

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  • Giovanni Villani
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    Abstract

    The real option theory provides a useful tool to evaluate an R&D investment under uncertainty because, unlike the NPV (Net Present Value), it considers the managerial flexibility that may be expand the investment opportunity value. However, most R&D investment projects are open to competing firms in the same industry or line of business, and so the strategic considerations become extremely important. In this paper we analyze a real option game between two firms that invest in R&D. The firm that invests first, defined as the Leader, acquires a first mover advantage that we assume as a higher market share than other one, namely the Follower, that postpones its R&D investment decision. But, several R&D investments present positive externalities and so, the option exercise by the Leader generates an “Information Revelation” that benefits the Follower. Moreover, to value the flexibility time to realize the development phase, we consider the American-Exchange type options.

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    Bibliographic Info

    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2728.

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    Date of creation: 2009
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    Handle: RePEc:ces:ceswps:_2728

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    Related research

    Keywords: American Exchange options; game theory; Montecarlo simulation; R&D; information revelation;

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    1. Saman Majd & Robert S. Pindyck, 1987. "Time to Build, Option Value, and Investment Decisions," NBER Working Papers 1654, National Bureau of Economic Research, Inc.
    2. Flavia Cortelezzi & Giovanni Villani, 2008. "Valuation of R&D Sequential Exchange Options using Monte Carlo approach," Quaderni DSEMS 04-2008, Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia.
    3. Moon Hoe Lee, 1997. "Valuing Finite-Maturity Investment-Timing Options," Financial Management, Financial Management Association, vol. 26(2), Summer.
    4. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
    5. Flavia Cortelezzi & Giovanni Villani, 2007. "Strategic Technology Adoption and Market Dynamics as Option Games," Quaderni DSEMS 14-2007, Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia.
    6. Carr, Peter P, 1988. " The Valuation of Sequential Exchange Opportunities," Journal of Finance, American Finance Association, vol. 43(5), pages 1235-56, December.
    7. Armada, Manuel Rocha & Kryzanowski, Lawrence & Pereira, Paulo Jorge, 2007. "A modified finite-lived American exchange option methodology applied to real options valuation," Global Finance Journal, Elsevier, vol. 17(3), pages 419-438, March.
    8. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
    9. Trigeorgis, Lenos, 1991. "Anticipated competitive entry and early preemptive investment in deferrable projects," Journal of Economics and Business, Elsevier, vol. 43(2), pages 143-156, May.
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