Priority Option: The Value of Being a Leader in Complete and Incomplete Markets

33 Pages Posted: 13 Aug 2012

See all articles by Matheus R. Grasselli

Matheus R. Grasselli

McMaster University

Vincent Leclere

affiliation not provided to SSRN

Michael Ludkovski

University of California, Santa Barbara

Date Written: August 12, 2012

Abstract

We consider the strategic interaction between two firms competing for the opportunity to invest in a project with uncertain future values. Starting in complete markets, we provide a rigorous characterization of the strategies followed by each firm in continuous time in the context of a timing/coordination game. In particular, the roles of leader and follower emerge from the resulting symmetric, Markov, sub-game perfect equilibrium. Comparing the expected value obtained by each firm in this case with that obtained when the roles of leader and follower are predetermined, we are able to calculate the amount of money that a firm would be willing to spend in advance (either by paying a license or acquiring market power) to have the right to be the leader in a subsequent game - what we call the priority option. We extend these results to incomplete markets by using utility - indifference arguments.

Keywords: real options, duopoly game, strategic competition

Suggested Citation

Grasselli, Matheus R. and Leclere, Vincent and Ludkovski, Mike, Priority Option: The Value of Being a Leader in Complete and Incomplete Markets (August 12, 2012). Available at SSRN: https://ssrn.com/abstract=2128220 or http://dx.doi.org/10.2139/ssrn.2128220

Matheus R. Grasselli

McMaster University ( email )

Vincent Leclere

affiliation not provided to SSRN ( email )

Mike Ludkovski (Contact Author)

University of California, Santa Barbara ( email )

Santa Barbara, CA 93106
United States

HOME PAGE: http://www.pstat.ucsb.edu/faculty/ludkovski

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