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Real Options in an Aymmetric Duopoly : Who Benefits from your Competitive Disadvantage

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  • Pawlina, G.

    (Tilburg University, Center For Economic Research)

  • Kort, P.M.

    (Tilburg University, Center For Economic Research)

Abstract

This paper considers the impact of investment cost asymmetry on the value and optimal real option exercise strategies of firms under imperfect competition.Both firms have an opportunity to invest in a project enhancing (ceteris paribus) the profit now.We show that three types of equilibria exist and derive critical levels of cost asymmetry separating the regions in which they prevail.The presence of strategic interactions leads to counter-intuitive results.First, depending on the level of asymmetry, a marginal increase in the investment cost of the firm with the cost disadvantage can increase this firm's own value.Second, such a cost increase can result in a decrease in value of the competitor.Moreover, we discuss the welfare implications of the optimal exercise strategies and show that the presence of identical firms can result in a socially less desirable outcome than if one of the competitors has a significant investment cost disadvantage.Finally, we prove that profit uncertainty always delays investment, even in the presence of a strategic option of becoming the first investor.

Suggested Citation

  • Pawlina, G. & Kort, P.M., 2001. "Real Options in an Aymmetric Duopoly : Who Benefits from your Competitive Disadvantage," Discussion Paper 2001-95, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:e997e0f6-3d0f-4cbe-b97a-c266e541078d
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    References listed on IDEAS

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    1. Décamps, Jean-Paul & Mariotti, Thomas, 2000. "Irreversible Investment and Learning Externalities," IDEI Working Papers 97, Institut d'Économie Industrielle (IDEI), Toulouse.
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    3. Enrico Perotti & Silvia Rossetto, 2000. "Internet Portals as Portfolios of Entry Options," Tinbergen Institute Discussion Papers 00-105/2, Tinbergen Institute.
    4. Luigi Guiso & Giuseppe Parigi, 1999. "Investment and Demand Uncertainty," The Quarterly Journal of Economics, Oxford University Press, vol. 114(1), pages 185-227.
    5. Robert Lensink & Hong Bo & Elmer Sterken, 2001. "Investment, Capital Market Imperfections, and Uncertainty," Books, Edward Elgar Publishing, number 1770.
    6. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716.
    7. Wesley M. Cohen & Daniel A. Levinthal, 1994. "Fortune Favors the Prepared Firm," Management Science, INFORMS, vol. 40(2), pages 227-251, February.
    8. Grenadier, Steven R, 1999. "Information Revelation through Option Exercise," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 95-129.
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    10. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
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    More about this item

    Keywords

    options; duopoly; capital budgeting; social welfare; investment;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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