Preemption in a real option game with a first mover advantage and player-specific uncertainty (Q617690): Difference between revisions

There are two players both of whom can invest in an project by paying a fixed cost \(I>0\). Players' payoffs are influenced by a random shock. The shock for player \(i\) is a stochastic process \(Y_i\) which follows a geometric Brownian motion \(dY_i/Y_i=\mu dt+\sigma dz_i, Y_i(0)=y_i,\) where \(z_1\) and \(z_2\) are correlated Wiener processes. Each moment \( t\) player \(i\) obtains the discounted payoff \(e^{-rt}D_{k,l} Y_i(t)\) which depends on the investment status \(k\) of the player. Here \(k=1\) if she has invested and k=0, otherwise, and \(l\) denotes the other player's investment status. It is assumed that \(D_{10}>D_{11}>D_{00}\geq D_{01}\) and there is a first mover advantage in that \(D_{10}-D_{00}>D_{11}-D_{01}\). This game is an extension of the model studied by Huisman and Kort (1999). It is shown that there exists an equilibrium which has different properties from those in standard real option games driven by common stochastic shocks.