Real options game over the business cycle

Hsing-Hua Huang*, Wei Liang Chuang

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

This paper studies the impact of business cycles on firms' strategic investment decisions by developing and solving a continuous time regime-dependent real options game in an asymmetric duopoly. The value functions, roles and optimal investment timing decisions of the two firms in the expansion and recession states are jointly determined. We show that the preemptive investment equilibrium, where the leader invests earlier than its own first-best investment timing, is pro-cyclical. Moreover, the simultaneous investment equilibrium, where the firms simultaneously invest late and enjoy waiting flexibility as a tacit collusion, is counter-cyclical. In addition, we specifically demonstrate that the values of the leader and follower in the expansion state are smaller than those in the recession state when the preemptive equilibrium prevails in the expansion state and the simultaneous equilibrium prevails in the recession state.

Original languageEnglish
Pages (from-to)715-721
Number of pages7
JournalEconomic Modelling
Volume35
DOIs
StatePublished - 1 Sep 2013

Keywords

  • Business cycle
  • Preemption game
  • Real options

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