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Lumps and Clusters in Duopolistic Investment Games: An Early Exercise Premium Approach

  • Doriana Ruffino

    ()

    (Boston University, Department of Economics)

  • Jonathan Treussard

    ()

    (Boston University, Department of Economics)

This paper exploits the early exercise premium representation to investigate strate- gic investment policies in a duopolistic continuous-time real options game. Assuming exogenous firm roles, we find that (i) as the leader installs its newly purchased capital, the follower's optimal investment policy displays a monotonically decreasing pattern, which finds its justifcation in the temporary reallocation of the leader's revenues to its competitor, and (ii) once the leader has completed its investment process, the follower's trigger boundary is proportional to the fixed cost of investment weighted by the present value of future revenues per unit of market demand. Moreover, we demonstrate that the follower's willingness to delay investment is enhanced by a longer time-to-build and a more volatile market demand, while it is weakened by a higher quality improvement upon replacement and by a higher expected growth in market demand. Finally, we study the probability that the follower mimics the leader?s decision within the leader's time-to-build window.

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Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Working Papers Series with number WP2006-044.

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Length: 50 pages
Date of creation: Aug 2006
Date of revision:
Handle: RePEc:bos:wpaper:wp2006-044
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  1. Richard J. Gilbert & Richard G. Harris, 1984. "Competition with Lumpy Investment," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 197-212, Summer.
  2. Grossman, G.M. & Helpman, E., 1989. "Quality Ledders In The Theory Of Growth," Papers 148, Princeton, Woodrow Wilson School - Public and International Affairs.
  3. Siim Kallast & Andi Kivinukk, 2003. "Pricing and Hedging American Options Using Approximations by Kim Integral Equations," Review of Finance, Springer, vol. 7(3), pages 361-383.
  4. Francois Gourio & Anil K Kashyap, 2007. "Investment Spikes: New Facts and a General Equilibrium Exploration," NBER Working Papers 13157, National Bureau of Economic Research, Inc.
  5. repec:dgr:kubcen:20036 is not listed on IDEAS
  6. Broadie, Mark & Detemple, Jerome, 1996. "American Option Valuation: New Bounds, Approximations, and a Comparison of Existing Methods," Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1211-50.
  7. Caballero, Ricardo J & Pindyck, Robert S, 1996. "Uncertainty, Investment, and Industry Evolution," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(3), pages 641-62, August.
  8. 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.
  9. Huisman, K.J.M. & Kort, P.M. & Pawlina, G. & Thijssen, J.J.J., 2003. "Strategic Investment Under Uncertainty : Merging Real Options with Game Theory," Discussion Paper 2003-6, Tilburg University, Center for Economic Research.
  10. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  11. repec:dgr:kubcen:200669 is not listed on IDEAS
  12. Huisman, K.J.M. & Kort, P.M., 1998. "A Further Analysis on Strategic Timing of Adoption of New Technologies under Uncertainty," Discussion Paper 1998-03, Tilburg University, Center for Economic Research.
  13. Peter Carr & Robert Jarrow & Ravi Myneni, 1992. "Alternative Characterizations Of American Put Options," Mathematical Finance, Wiley Blackwell, vol. 2(2), pages 87-106.
  14. John Haltiwanger & Russell Cooper & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September.
  15. Stenbacka, Rune & Tombak, Mihkel M., 1994. "Strategic timing of adoption of new technologies under uncertainty," International Journal of Industrial Organization, Elsevier, vol. 12(3), pages 387-411, September.
  16. Doriana Ruffino & Jonathan Treussard, 2006. "A Study of Inaction in Investment Games via the Early Exercise Premium Representation," Boston University - Department of Economics - Working Papers Series WP2006-040, Boston University - Department of Economics.
  17. repec:dgr:kubcen:199803 is not listed on IDEAS
  18. S. D. Jacka, 1991. "Optimal Stopping and the American Put," Mathematical Finance, Wiley Blackwell, vol. 1(2), pages 1-14.
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