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Real Options, Preemption, and the Dynamics of Industry Investments

  • Marcel Boyer

    (Université de Montréal and CIRANO)

  • Pierre Lasserre

    ()

    (Economics Department, UQAM, GREQAM and CIRANO)

  • Thomas Mariotti

    (GREMAQ and Université de Toulouse I)

  • Michel Moreaux

    (Institut Universitaire de France, Université de Toulouse I, IDEI and LEERNA)

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.

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Paper provided by Université du Québec à Montréal, Département des sciences économiques in its series Cahiers de recherche du Département des sciences économiques, UQAM with number 20-10.

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Length: 43
Date of creation: Oct 2001
Date of revision:
Handle: RePEc:cre:uqamwp:20-10
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  1. Richard J. Gilbert & Richard G. Harris, 1984. "Competition with Lumpy Investment," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 197-212, Summer.
  2. Décamps, Jean-Paul & Mariotti, Thomas, 2000. "Irreversible Investment and Learning Externalities," IDEI Working Papers 97, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. 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.
  4. Weeds, Helen, 2002. "Strategic Delay in a Real Options Model of R&D Competition," Review of Economic Studies, Wiley Blackwell, vol. 69(3), pages 729-47, July.
  5. 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.
  6. Athey, Susan & Schmutzler, Armin, 2001. "Investment and Market Dominance," RAND Journal of Economics, The RAND Corporation, vol. 32(1), pages 1-26, Spring.
  7. 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.
  8. 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.
  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. Bart Lambrecht & William Perraudin, 1996. "Real Options and Preemption," Archive Working Papers 026, Birkbeck, Department of Economics, Mathematics & Statistics.
  11. 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.
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