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Real Options, Preemption, and the Dynamics of Industry Investments

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  • Marcel Boyer
  • Pierre Lasserre
  • Thomas Mariotti
  • Michel Moreaux

Abstract

We study the development of a duopoly industry -evolution of firm capacities and competitive behavior- in a continuous-time real-options model of capacity investment. Our methodology allows the evaluation of investment options and exercise rules in a strategic setup. In the initial industry development phase, firms attempt to preempt each other, so that the first industry investment occurs earlier than socially optimal and the first entrant takes more risk than socially optimal. While capacity units are costly, indivisible, durable, and big relative to market size, early entry cannot secure a first-mover advantage, so that both firms are active beyond some level of market development. Once both firms hold capacity, tacit collusion, taking the form of postponed capacity investment, may occur in Markov Perfect Equilibrium. Volatility and the expected speed of market development play a crucial role in the determination of competitive behavior: we show that a tacit-collusion equilibrium is certain to exist when market growth is highly volatile and/or very fast. Nous étudions le développement d'une industrie -capacités et comportement concurrentiel- dans un modèle en temps continu d'options réelles d'investissement en capacité. Notre méthodologie permet l'évaluation des options et des règles d'exercice en contexte stratégique. Initialement, les firmes ont un comportement de préemption, si bien que le premier investissement en capacité se produit plus tôt, et comporte un risque plus élevé, que socialement désirable. Bien que les unités de capacité soient coûteuses, indivisibles, durables et de taille non négligeable par rapport au marché, l'entrée hâtive ne peut conférer d'avantage durable; à partir d'un certain niveau de développement du marché, les deux firmes sont en activité. Alors, une collusion tacite pour retarder les augmentations de capacité subséquentes peut devenir possible en équilibre Markovien parfait. La volatilité du marché et sa vitesse de croissance jouent ici un rôle crucial: l'équilibre de collusion tacite existe si la croissance est très volatile et/ou très rapide.

Suggested Citation

  • Marcel Boyer & Pierre Lasserre & Thomas Mariotti & Michel Moreaux, 2001. "Real Options, Preemption, and the Dynamics of Industry Investments," CIRANO Working Papers 2001s-64, CIRANO.
  • Handle: RePEc:cir:cirwor:2001s-64
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    File URL: http://www.cirano.qc.ca/files/publications/2001s-64.pdf
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    References listed on IDEAS

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    1. Fudenberg, Drew & Gilbert, Richard & Stiglitz, Joseph & Tirole, Jean, 1983. "Preemption, leapfrogging and competition in patent races," European Economic Review, Elsevier, vol. 22(1), pages 3-31, June.
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    Cited by:

    1. Thijssen, J.J.J., 2003. "Investment under uncertainty, market evolution and coalition spillovers in a game theoretic perspective," Other publications TiSEM 672073a6-492e-4621-8d4a-0, Tilburg University, School of Economics and Management.
    2. Huisman, Kuno J. M. & Kort, Peter M., 2004. "Strategic technology adoption taking into account future technological improvements: A real options approach," European Journal of Operational Research, Elsevier, vol. 159(3), pages 705-728, December.
    3. Thijssen, Jacco J. J. & Huisman, Kuno J. M. & Kort, Peter M., 2004. "The effect of information streams on capital budgeting decisions," European Journal of Operational Research, Elsevier, vol. 157(3), pages 759-774, September.
    4. 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.
    5. Boyer, Marcel & Lasserre, Pierre & Moreaux, Michel, 2012. "A dynamic duopoly investment game without commitment under uncertain market expansion," International Journal of Industrial Organization, Elsevier, vol. 30(6), pages 663-681.
    6. Jacco Thijssen & Kuno Huisman & Peter Kort, 2006. "The effects of information on strategic investment and welfare," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(2), pages 399-424, June.
    7. 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.
    8. Boyer, Marcel & Lasserre, Pierre & Moreaux, Michel, 2010. "A Dynamic Duopoly Investment Game under Uncertain Market Growth," IDEI Working Papers 617, Institut d'Économie Industrielle (IDEI), Toulouse.
    9. Francisco Ruiz-Aliseda, 2003. "Strategic Commitment Versus Flexibility in a Duopoly with Entry and Exit," Discussion Papers 1379, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    10. Maria Cecillia Bustamante, 2011. "Strategic Investment, Industry Concentration and the Cross Section of Returns," FMG Discussion Papers dp681, Financial Markets Group.
    11. Boyer, Marcel & Robert, Jacques, 2006. "Organizational inertia and dynamic incentives," Journal of Economic Behavior & Organization, Elsevier, vol. 59(3), pages 324-348, March.
    12. Bustamante, Maria Cecilia, 2011. "Strategic investment, industry concentration and the cross section of returns," LSE Research Online Documents on Economics 37454, London School of Economics and Political Science, LSE Library.

    More about this item

    Keywords

    Real options; Option value; Duopoly; Preemption; Collusion; Capacity; Industry growth; Volatility; Risk ; Options réelles; Valeur d'option; Duopole; Préemption; Collusion; Capacité; Croissance du marché; Volatilité; Risque;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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