Preemptive Capacity Investment Under Uncertainty
18 Pages Posted: 23 Jan 2011 Last revised: 24 Jun 2012
Date Written: February 18, 2011
The incentive to 'overinvest' in capital may be eroded in dynamic, competitive settings if firms face uncertainty and irreversibility. In this paper, we derive the stationary Markov perfect equilibrium for a dynamic, infinite-horizon capacity investment game formulated in continuous time in which reduced-form profits are subject to industry shocks. We show that the theory of marginal Tobin's q still holds in capital-accumulation games under uncertainty if the strategic externalities of rivals' investment are properly accounted for.
Keywords: financial economics, strategic investment under uncertainty, real options, stochastic differential games, capital accumulation
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