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Investment in Next Generation Networks and the Role of Regulation: A Real Option Approach

  • Andrea Gavosto
  • Guido Ponte
  • Carla Scaglioni
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    The current regulatory debate in the telecommunications industry in Europe and elsewhere is dominated by the issue of if and how to regulate next generation networks (NGN) which operators plan to roll out in the near future. The crucial issue is whether an extension of current regulatory obligations onto future networks would hamper the investment by large European operators. The paper applies a real option model to explain the investment decision in next generation networks. One important result of the model is that regulation affects the investment decision only in the initial period when uncertainty is still very high. The real option model has been calibrated with parameters drawn from real data for a new entrant and from educated estimates for an established operator. Four different regulatory regimes and their impact on the timing of the investments have been simulated: a temporary regulatory holiday is shown to be an effective regulatory tool in order to induce immediate investments.

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    Paper provided by ISEG - School of Economics and Management, Department of Economics, University of Lisbon in its series Working Papers Department of Economics with number 2007/31.

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    Date of creation: 2007
    Date of revision:
    Handle: RePEc:ise:isegwp:wp312007
    Contact details of provider: Postal: Department of Economics, ISEG - School of Economics and Management, University of Lisbon, Rua do Quelhas 6, 1200-781 LISBON, PORTUGAL
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    1. Beard, T. Randolph & Kaserman, David L. & Mayo, John W., 2003. "Regulation, competition, and the optimal recovery of stranded costs," International Journal of Industrial Organization, Elsevier, vol. 21(6), pages 831-848, June.
    2. Geske, Robert & Shastri, Kuldeep, 1985. "Valuation by Approximation: A Comparison of Alternative Option Valuation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(01), pages 45-71, March.
    3. Pindyck Robert S., 2007. "Mandatory Unbundling and Irreversible Investment in Telecom Networks," Review of Network Economics, De Gruyter, vol. 6(3), pages 1-25, September.
    4. Evans, Lewis & Guthrie, Graeme, 2005. "Risk, Price Regulation, and Irreversible Investment," Working Paper Series 3880, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    5. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    7. Ian M. Dobbs, 2004. "Intertemporal price cap regulation under uncertainty," Economic Journal, Royal Economic Society, vol. 114(495), pages 421-440, 04.
    8. Jerry A. Hausman, 1997. "Valuing the Effect of Regulation on New Services in Telecommunications," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1997 Micr), pages 1-54.
    9. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    10. Sarmento, Paula & Brandão, António, 2007. "Access pricing: A comparison between full deregulation and two alternative instruments of access price regulation, cost-based and retail-minus," Telecommunications Policy, Elsevier, vol. 31(5), pages 236-250, June.
    11. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, vol. 44(4), pages 925-972, December.
    12. repec:tpr:qjecon:v:101:y:1986:i:4:p:707-27 is not listed on IDEAS
    13. James E. Smith & Robert F. Nau, 1995. "Valuing Risky Projects: Option Pricing Theory and Decision Analysis," Management Science, INFORMS, vol. 41(5), pages 795-816, May.
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