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Strategic real options with stochastic volatility in a duopoly model

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  • Huang, Bing
  • Cao, Jiling
  • Chung, Hyuck
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    Abstract

    The investment-timing problem has been considered by many authors under the assumption that the instantaneous volatility of the demand shock is constant. Recently, Ting et al. [9] carried out an asymptotic approach in a monopoly model by letting the volatility parameter follow a stochastic process. In this paper, we consider a strategic game in which two firms compete for a new market under an uncertain demand, and extend the analysis of Ting et al. to duopoly models under different strategic game structures. In particular, we investigate how the additional uncertainty in the volatility affects the investment thresholds and payoffs of players. Several numerical examples and comparison of the results are provided to confirm our analysis.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 45731.

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    Date of creation: 18 Mar 2013
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    Handle: RePEc:pra:mprapa:45731

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    Keywords: Asymptotic solution; Real option; Stochastic duopoly game; Stochastic volatility.;

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    1. 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.
    2. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 58(2), pages 135-57, April.
    3. Ting, Sai Hung Marten & Ewald, Christian-Oliver & Wang, Wen-Kai, 2013. "On the investment–uncertainty relationship in a real option model with stochastic volatility," Mathematical Social Sciences, Elsevier, Elsevier, vol. 66(1), pages 22-32.
    4. Graham, Jeffrey, 2011. "Strategic real options under asymmetric information," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(6), pages 922-934, June.
    5. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-43.
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