Investment timing and capacity choice in duopolistic competition under a jump-diffusion model

Area of Science:

• Economics
• Finance
• Game Theory

Background:

• Real options theory is crucial for understanding investment decisions under uncertainty.
• Duopoly markets face complex strategic interactions and investment timing challenges.
• Sudden events (jumps) significantly impact market dynamics and firm behavior.

Purpose of the Study:

• To apply real options game theory to analyze investment timing and capacity in duopolies facing sudden events.
• To develop a novel computational method for real option models with random jump processes.
• To investigate the impact of demand and investment cost uncertainties on firms' strategic decisions.

Main Methods:

• Utilizing real options game theory with geometric Brownian motions and Poisson processes to model demand and costs.
• Developing a distribution-independent computational method for real option valuation with jumps.
• Employing numerical simulations to explore various uncertainty scenarios and jump impacts.

Main Results:

• Increased uncertainty in demand and investment costs leads both firms to delay investment and choose larger capacities.
• The optimal capacity relationship between firms in a duopoly becomes ambiguous with dual uncertainty sources.
• Upward demand jumps and downward investment cost jumps accelerate investment with larger capacities; vice versa.

Conclusions:

• Firms strategically delay investment and adjust capacity in response to increased market uncertainty and sudden events.
• The interplay of demand and cost uncertainties, along with jump dynamics, creates complex strategic investment landscapes.
• In symmetric duopolies, preemption threats can lead to earlier investment by the first mover compared to asymmetric settings.