Real Options, Preemption, and the Dynamics of Industry Investments

Marcel Boyer, Pierre Lasserre, Thomas Mariotti and Michel Moreaux
Additional contact information
Thomas Mariotti: GREMAQ and Université de Toulouse I

No 20-10, Cahiers de recherche du Département des sciences économiques, UQAM from Université du Québec à Montréal, Département des sciences économiques

Abstract: 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.

Keywords: Real options; Option value; Duopoly; Preemption; Collusion; Capacity; Industry growth; Volatility; Risk - Options réelles; Valeur d'option; Duopole; Préemption; Collusion; Capacité; Croissance du marché; Volatilité; Risque. (search for similar items in EconPapers)
JEL-codes: C73 D43 D92 L13 (search for similar items in EconPapers)
Pages: 43
Date: 2001-10
New Economics Papers: this item is included in nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (17)

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Working Paper: Real Options, Preemption, and the Dynamics of Industry Investments (2001)
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