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Leaders, followers, and equity risk premiums in booms and busts

Makoto Goto, Katsumasa Nishide and Ryuta Takashima

Journal of Banking & Finance, 2017, vol. 81, issue C, 207-220

Abstract: We study an investment problem in which two asymmetric firms face competition and the regime characterizing the economic condition follows a Markov switching process. We derive the value functions and investment thresholds of the leader and follower. The option value of regime uncertainty is found to be quite important for the investment decision of firms. We also show the relationship between the equity risk premium and the economic cycle that has not been done in previous studies, which proxy economic conditions by the level of demand or other state variables.

Keywords: Real options; Competition; Risk premium; Regime uncertainty (search for similar items in EconPapers)
JEL-codes: C73 D43 D81 E32 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:jbfina:v:81:y:2017:i:c:p:207-220