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

Listed author(s):
  • 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
Handle: RePEc:bos:wpaper:wp2006-044
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