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Priority Option: The Value Of Being A Leader

Author

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  • M. R. GRASSELLI

    (McMaster University, 1280 Main Street West, Hamilton, ON, L8P 1P6, Canada)

  • V. LECLÈRE

    (École des Ponts ParisTech, 6 – 8 Avenue Blaise Pascal, 77455 Marne la Vallée, France)

  • M. LUDKOVSKI

    (University of California, Santa Barbara, Santa Barbara, CA 93106-3110, USA)

Abstract

We consider the strategic interaction between two firms competing for the opportunity to invest in a project with uncertain future values. Starting in complete markets, we provide a rigorous characterization of the strategies followed by each firm in continuous time in the context of a timing/coordination game. In particular, the roles of leader and follower emerge from the resulting symmetric, Markov, sub-game perfect equilibrium. Comparing the expected value obtained by each firm in this case with that obtained when the roles of leader and follower are predetermined, we are able to calculate the amount of money that a firm would be willing to spend in advance (either by paying a license or acquiring market power) to have the right to be the leader in a subsequent game — what we call the priority option. We extend these results to incomplete markets by using utility-indifference arguments.

Suggested Citation

  • M. R. Grasselli & V. Leclère & M. Ludkovski, 2013. "Priority Option: The Value Of Being A Leader," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(01), pages 1-37.
    • Handle: RePEc:wsi:ijtafx:v:16:y:2013:i:01:n:s0219024913500040
    DOI: 10.1142/S0219024913500040
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    References listed on IDEAS

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    1. Thijssen, Jacco J.J. & Huisman, Kuno J.M. & Kort, Peter M., 2012. "Symmetric equilibrium strategies in game theoretic real option models," Journal of Mathematical Economics, Elsevier, vol. 48(4), pages 219-225.
    2. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    3. Jacco J.J. Thijssen, "undated". "Equilibria in Continuous Time Preemption Games with Markovian Payoffs," Discussion Papers 11/17, Department of Economics, University of York.
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    Cited by:

    1. Huang, Bing & Cao, Jiling & Chung, Hyuck, 2014. "Strategic real options with stochastic volatility in a duopoly model," Chaos, Solitons & Fractals, Elsevier, vol. 58(C), pages 40-51.
    2. Liangchen Li & Michael Ludkovski, 2018. "Stochastic Switching Games," Papers 1807.03893, arXiv.org.

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