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A Strategic R&D Investment with Flexible Development Time in Real Option Game Analysis

  • Giovanni Villani
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    The real option theory provides a useful tool to evaluate an R&D investment under uncertainty because, unlike the NPV (Net Present Value), it considers the managerial flexibility that may be expand the investment opportunity value. However, most R&D investment projects are open to competing firms in the same industry or line of business, and so the strategic considerations become extremely important. In this paper we analyze a real option game between two firms that invest in R&D. The firm that invests first, defined as the Leader, acquires a first mover advantage that we assume as a higher market share than other one, namely the Follower, that postpones its R&D investment decision. But, several R&D investments present positive externalities and so, the option exercise by the Leader generates an “Information Revelation” that benefits the Follower. Moreover, to value the flexibility time to realize the development phase, we consider the American-Exchange type options.

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    File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2009/wp-cesifo-2009-07/cesifo1_wp2728.pdf
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    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2728.

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    Date of creation: 2009
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    Handle: RePEc:ces:ceswps:_2728
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    1. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
    2. Moon Hoe Lee, 1997. "Valuing Finite-Maturity Investment-Timing Options," Financial Management, Financial Management Association, vol. 26(2), Summer.
    3. Trigeorgis, Lenos, 1991. "Anticipated competitive entry and early preemptive investment in deferrable projects," Journal of Economics and Business, Elsevier, vol. 43(2), pages 143-156, May.
    4. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
    5. Flavia Cortelezzi & Giovanni Villani, 2007. "Strategic Technology Adoption and Market Dynamics as Option Games," Quaderni DSEMS 14-2007, Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia.
    6. Flavia Cortelezzi & Giovanni Villani, 2009. "Valuation of R&D Sequential Exchange Options Using Monte Carlo Approach," Computational Economics, Society for Computational Economics, vol. 33(3), pages 209-236, April.
    7. Armada, Manuel Rocha & Kryzanowski, Lawrence & Pereira, Paulo Jorge, 2007. "A modified finite-lived American exchange option methodology applied to real options valuation," Global Finance Journal, Elsevier, vol. 17(3), pages 419-438, March.
    8. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
    9. Carr, Peter P, 1988. " The Valuation of Sequential Exchange Opportunities," Journal of Finance, American Finance Association, vol. 43(5), pages 1235-56, December.
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