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Real options in an asymmetric duopoly: : who benefits from your competitive disadvantage

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Author Info
Pawlina, G.
Kort, P.M. (Tilburg University, Center for Economic Research)

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Abstract

This paper considers the impact of investment cost asymmetry on the value and optimal real option exercise strategies of firms under imperfect competition. Both firms have an opportunity to invest in a project enhancing (ceteris paribus) the profit now. We show that three types of equilibria exist and derive critical levels of cost asymmetry separating the regions in which they prevail. The presence of strategic interactions leads to counter-intuitive results. First, depending on the level of asymmetry, a marginal increase in the investment cost of the firm with the cost disadvantage can increase this firm's own value. Second, such a cost increase can result in a decrease in value of the competitor. Moreover, we discuss the welfare implications of the optimal exercise strategies and show that the presence of identical firms can result in a socially less desirable outcome than if one of the competitors has a significant investment cost disadvantage. Finally, we prove that profit uncertainty always delays investment, even in the presence of a strategic option of becoming the first investor.

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Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 95.

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Date of creation: 2001
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Handle: RePEc:dgr:kubcen:200195

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Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Han T. J. Smit & L. A. Ankum, 1993. "A Real Options and Game-Theoretic Approach to," Financial Management, Financial Management Association, vol. 22(3), Fall.
  2. Grenadier, Steven R, 1996. " The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets," Journal of Finance, American Finance Association, vol. 51(5), pages 1653-79, December. [Downloadable!] (restricted)
  3. Robin Mason & Helen Weeds, 2000. "Networks, Options and Preemption," Econometric Society World Congress 2000 Contributed Papers 1721, Econometric Society. [Downloadable!]
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  4. Décamps, Jean-Paul & Mariotti, Thomas, 2000. "Irreversible Investment and Learning Externalities," IDEI Working Papers 97, Institut d'Économie Industrielle (IDEI), Toulouse.
  5. Williams, Joseph T, 1993. "Equilibrium and Options on Real Assets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 6(4), pages 825-50. [Downloadable!] (restricted)
  6. Fudenberg, Drew & Tirole, Jean, 1985. "Preemption and Rent Equilization in the Adoption of New Technology," Review of Economic Studies, Blackwell Publishing, vol. 52(3), pages 383-401, July. [Downloadable!] (restricted)
  7. Grenadier, Steven R, 1999. "Information Revelation through Option Exercise," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 12(1), pages 95-129.
  8. Luigi Guiso & Giuseppe Parigi, 1999. "Investment And Demand Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 114(1), pages 185-227, February. [Downloadable!] (restricted)
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  9. Reinganum, Jennifer F, 1981. "On the Diffusion of New Technology: A Game Theoretic Approach," Review of Economic Studies, Blackwell Publishing, vol. 48(3), pages 395-405, July. [Downloadable!] (restricted)
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  10. Enrico Perotti & Silvia Rossetto, 2000. "Internet Portals as Portfolios of Entry Options," Tinbergen Institute Discussion Papers 00-105/2, Tinbergen Institute. [Downloadable!]
  11. Stefanie Kleimeier & William L. Megginson, 2000. "Are Project Finance Loans Different From Other Syndicated Credits?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(1), pages 75-87. [Downloadable!] (restricted)
  12. 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. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Michele Moretto, 2007. "Competition and Irreversible Investments under Uncertainty," "Marco Fanno" Working Papers 0058, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
  2. BOBTCHEFF Catherine, 2008. "Real Options and Technology Choice under Bertrand Competition," Working Papers 08.16.260, LERNA, University of Toulouse. [Downloadable!]
  3. Bruno Versaevel, 2009. "Cumulative Leadership and Entry Dynamics," Post-Print halshs-00371847_v1, HAL. [Downloadable!]
    Other versions:
  4. Thijssen, J.J.J. & Huisman, K.J.M. & Kort, P.M., 2002. "Symmetric equilibrium strategies in game theoretical real option models," Discussion Paper 81, Tilburg University, Center for Economic Research. [Downloadable!]
  5. Kort, P.M. & Huisman, K.J.M. & Pawlina, G. & Thijssen, J.J., 2003. "Strategic investment under uncertainty: merging real options with game theory," Discussion Paper 6, Tilburg University, Center for Economic Research. [Downloadable!]
  6. Gianluca Femminis & Gianmaria Martini, 2008. "Irreversible R&D investment with inter-firm spillovers," DISCE - Quaderni dell'Istituto di Teoria Economica e Metodi Quantitativi itemq0850, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE). [Downloadable!]
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