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

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  • Doriana Ruffino

    () (Boston University, Department of Economics)

  • Jonathan Treussard

    () (Boston University, Department of Economics)

Abstract

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.

Suggested Citation

  • Doriana Ruffino & Jonathan Treussard, 2006. "Lumps and Clusters in Duopolistic Investment Games: An Early Exercise Premium Approach," Boston University - Department of Economics - Working Papers Series WP2006-044, Boston University - Department of Economics.
  • Handle: RePEc:bos:wpaper:wp2006-044
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    References listed on IDEAS

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    Cited by:

    1. Gryglewicz, Sebastian & Huisman, Kuno J.M. & Kort, Peter M., 2008. "Finite project life and uncertainty effects on investment," Journal of Economic Dynamics and Control, Elsevier, vol. 32(7), pages 2191-2213, July.

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