Lumps and Clusters in Duopolistic Investment Games: An Early Exercise Premium Approach
This paper investigates strategic investment policies in a duopolistic continuous-time real options game. Our contribution is twofold, economic and methodological. The former is the recognition that, under fixed costs of investment and time-to-build, a firm's exercise of its capital-replacement option leads to a significant temporary reallocation of the firm's revenues to its competitor. The latter is the introduction of the early exercise premium representation as a valuable device for the characterization of optimal exercise policies in real options games. Assuming exogenous firm roles, we find that (i) as the leader installs its newly purchased capital, the follower's optimal investment policy displays a markedly convex and monotonically decreasing pattern over time, which finds its justification in the temporary transfer of the leader's consumer demand to its competitor, and (ii) once the leader has completed its investment process, the follower's trigger boundary -- i.e., the level of market demand that renders capital replacement optimal -- is time-independent. Moreover, we demonstrate that the follower's willingness to delay investment is enhanced by a longer time-to-build and a more volatile market demand, while it is weakened by a higher quality improvement upon replacement and by a higher expected growth in market demand. Finally, we study the probability that the follower mimics the leader's decision within the leader's time-to-build window. We conclude that, while a higher quality advancement upon investment and a higher growth rate in market demand make it more likely for the follower to exercise its investment option promptly, a higher market uncertainty and a longer time-to-build alter the probability of an investment cluster non-monotonically.
|Date of creation:||2007|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Huisman, K.J.M. & Kort, P.M. & Pawlina, G. & Thijssen, J.J.J., 2004.
"Strategic investment under uncertainty : Merging real options with game theory,"
Other publications TiSEM
57b69510-cf54-479e-938e-d, Tilburg University, School of Economics and Management.
- 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.
- Grossman, G.M. & Helpman, E., 1989.
"Quality Ledders In The Theory Of Growth,"
148, Princeton, Woodrow Wilson School - Public and International Affairs.
- 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.
- Peter Carr & Robert Jarrow & Ravi Myneni, 1992. "Alternative Characterizations Of American Put Options," Mathematical Finance, Wiley Blackwell, vol. 2(2), pages 87-106.
- Russell Cooper & John Haltiwanger & Laura Power, 1995.
"Machine Replacement and the Business Cycle: Lumps and Bumps,"
0062, Boston University - Industry Studies Programme.
- John Haltiwanger & Russell Cooper & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September.
- Russell Cooper & John Haltiwanger & Laura Power, 1995. "Machine Replacement and the Business Cycle: Lumps and Bumps," NBER Working Papers 5260, National Bureau of Economic Research, Inc.
- 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.
- Huisman, K.J.M. & Kort, P.M., 1998. "A Further Analysis on Strategic Timing of Adoption of New Technologies under Uncertainty," Discussion Paper 1998-03, Tilburg University, Center for Economic Research.
- Stenbacka, Rune & Tombak, Mihkel M., 1994. "Strategic timing of adoption of new technologies under uncertainty," International Journal of Industrial Organization, Elsevier, vol. 12(3), pages 387-411, September.
- Doriana Ruffino & Jonathan Treussard, 2006. "A Study of Inaction in Investment Games via the Early Exercise Premium Representation," Boston University - Department of Economics - Working Papers Series WP2006-040, Boston University - Department of Economics.
When requesting a correction, please mention this item's handle: RePEc:red:sed007:77. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)
If references are entirely missing, you can add them using this form.