Real Options with Competition and Regime Switching

27 Pages Posted: 15 Jan 2017

See all articles by Alain Bensoussan

Alain Bensoussan

University of Texas at Dallas - Naveen Jindal School of Management; Hong Kong Polytechnic University - Faculty of Business; Ajou University

SingRu Hoe

University of Texas at Arlington - Department of Finance and Real Estate

Zhongfeng Yan

Jinan University

G. George Yin

Wayne State University

Date Written: January 2017

Abstract

In this paper, we examine irreversible investment decisions in duopoly games with a variable economic climate. Integrating timing flexibility, competition, and changes in the economic environment in the form of a cash flow process with regime switching, the problem is formulated as a stopping‐time game under Stackelberg leader‐follower competition, in which both players determine their respective optimal market entry time. By extending the variational inequality approach, we solve for the free boundaries and obtain optimal investment strategies for each player. Despite the lack of regularity in the leader's obstacle and the cash flow regime uncertainty, the regime‐dependent optimal policies for both the leader and the follower are obtained. In addition, we perform comprehensive numerical experiments to demonstrate the properties of solutions and to gain insights into the implications of regime switching.

Keywords: variational inequality, irreversible investment, real option, regime switching, game theory, optimal stopping problem

Suggested Citation

Bensoussan, Alain and Hoe, SingRu and Yan, Zhongfeng and Yin, G. George, Real Options with Competition and Regime Switching (January 2017). Mathematical Finance, Vol. 27, Issue 1, pp. 224-250, 2017, Available at SSRN: https://ssrn.com/abstract=2899168 or http://dx.doi.org/10.1111/mafi.12085

Alain Bensoussan (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

800 West Campbell Rd
SM 30
Richardson, TX 75080-3021
United States
9728836117 (Phone)

HOME PAGE: http://www.utdallas.edu/~axb046100/

Hong Kong Polytechnic University - Faculty of Business

Dept SEEM
Systems Engr * Engr Mgmt
Hong Kong, Hong Kong
China

Ajou University ( email )

Ajou
France

SingRu Hoe

University of Texas at Arlington - Department of Finance and Real Estate ( email )

Box 19449 UTA
Arlington, TX 76019
United States

Zhongfeng Yan

Jinan University

G. George Yin

Wayne State University

Detroit, MI 48202
United States

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