Real Option Games with Incomplete Information and Spillovers
50 Pages Posted: 20 Jan 2002
Date Written: December 2001
We model in a game theoretic context managerial intervention directed towards value enhancement in the presence of uncertainty and spillover effects. Two firms face real investment opportunities, and before making the irreversible investment decisions, they have options to enhance value by doing more R&D and/or acquiring more information. Due to spillovers, firms act strategically by optimizing their behavior, conditional on the actions of their counterpart. They face two decisions that are solved for interdependently in a two-stage game. The first-stage decision is: what is the optimal level of coordination between them? the second-stage decision is: what is the optimal effort for a given level of the spillover effects and the cost of information acquisition? For the solution we adopt an option pricing framework that allows analytic tractability.
Keywords: Real options, Incomplete information and learning, R&D coordination, 2-stage games
JEL Classification: G13, G31, C72, L00
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