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Real Options, Preemption, and the Dynamics of Industry Investments

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

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.

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Paper provided by CIRANO in its series CIRANO Working Papers with number 2001s-64.

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Length: 45 pages
Date of creation: 01 Nov 2001
Date of revision:
Handle: RePEc:cir:cirwor:2001s-64
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  1. Athey, Susan & Schmutzler, Armin, 2001. "Investment and Market Dominance," RAND Journal of Economics, The RAND Corporation, vol. 32(1), pages 1-26, Spring.
  2. Bart Lambrecht & William Perraudin, 1996. "Real Options and Preemption," Archive Working Papers 026, Birkbeck, Department of Economics, Mathematics & Statistics.
  3. Helen Weeds, 2002. "Strategic Delay in a Real Options Model of R&D Competition," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 729-747.
  4. Decamps, J.-P. & Mariotti, T., 2000. "Irreversible Investment and Learning Expternalities," Papers 00-534, Toulouse - GREMAQ.
  5. Gilbert, Richard & Harris, Richard G., 1984. "Competition with Lumpy Investment," Department of Economics, Working Paper Series qt11v5q20z, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  6. Leahy, John V, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1105-33, November.
  7. 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.
  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. Dasgupta, P. & Stiglitz, J. E., 1988. "Potential competition, actual competition, and economic welfare," European Economic Review, Elsevier, vol. 32(2-3), pages 569-577, March.
  10. Fudenberg, Drew & Tirole, Jean, 1985. "Preemption and Rent Equilization in the Adoption of New Technology," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 383-401, July.
  11. Harris, Christopher J & Vickers, John S, 1985. "Patent Races and the Persistence of Monopoly," Journal of Industrial Economics, Wiley Blackwell, vol. 33(4), pages 461-81, June.
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