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Investment in Next Generation Networks and the Role of Regulation: A Real Option Approach

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  • Andrea Gavosto
  • Guido Ponte
  • Carla Scaglioni
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    Abstract

    The current regulatory debate in the telecommunications industry in Europe and elsewhere is dominated by the issue of if and how to regulate next generation networks (NGN) which operators plan to roll out in the near future. The crucial issue is whether an extension of current regulatory obligations onto future networks would hamper the investment by large European operators. The paper applies a real option model to explain the investment decision in next generation networks. One important result of the model is that regulation affects the investment decision only in the initial period when uncertainty is still very high. The real option model has been calibrated with parameters drawn from real data for a new entrant and from educated estimates for an established operator. Four different regulatory regimes and their impact on the timing of the investments have been simulated: a temporary regulatory holiday is shown to be an effective regulatory tool in order to induce immediate investments.

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    File URL: http://pascal.iseg.utl.pt/~depeco/wp/wp312007.pdf
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    Bibliographic Info

    Paper provided by ISEG - School of Economics and Management, Department of Economics, University of Lisbon in its series Working Papers Department of Economics with number 2007/31.

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    Date of creation: 2007
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    Handle: RePEc:ise:isegwp:wp312007

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    Postal: Department of Economics, ISEG - School of Economics and Management, University of Lisbon, Rua do Quelhas 6, 1200-781 LISBON, PORTUGAL
    Web page: https://aquila1.iseg.ulisboa.pt/aquila/departamentos/EC

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    Keywords: real options; telecommunication; regulated industries; Next Generation Networks.;

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    1. Robert S. Pindyck, 2004. "Mandatory Unbundling and Irreversible Investment in Telecom Networks," NBER Working Papers 10287, National Bureau of Economic Research, Inc.
    2. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 101(4), pages 707-27, November.
    3. Sarmento, Paula & Brandão, António, 2007. "Access pricing: A comparison between full deregulation and two alternative instruments of access price regulation, cost-based and retail-minus," Telecommunications Policy, Elsevier, Elsevier, vol. 31(5), pages 236-250, June.
    4. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    5. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, vol. 44(4), pages 925-972, December.
    6. Beard, T. Randolph & Kaserman, David L. & Mayo, John W., 2003. "Regulation, competition, and the optimal recovery of stranded costs," International Journal of Industrial Organization, Elsevier, vol. 21(6), pages 831-848, June.
    7. Ian M. Dobbs, 2004. "Intertemporal price cap regulation under uncertainty," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 114(495), pages 421-440, 04.
    8. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    9. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    10. James E. Smith & Robert F. Nau, 1995. "Valuing Risky Projects: Option Pricing Theory and Decision Analysis," Management Science, INFORMS, INFORMS, vol. 41(5), pages 795-816, May.
    11. Evans, Lewis T. & Guthrie, Graeme A., 2005. "Risk, price regulation, and irreversible investment," International Journal of Industrial Organization, Elsevier, vol. 23(1-2), pages 109-128, February.
    12. Geske, Robert & Shastri, Kuldeep, 1985. "Valuation by Approximation: A Comparison of Alternative Option Valuation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(01), pages 45-71, March.
    13. Jerry A. Hausman, 1997. "Valuing the Effect of Regulation on New Services in Telecommunications," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1997 Micr), pages 1-54.
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