Investment under uncertainty, competition and regulation

TL;DR

This paper models a duopoly investment scenario with a randomized regulator, extending existing frameworks to unify and analyze strategic interactions, including effects of uncertainty and risk aversion.

Contribution

It introduces a generalized model of regulation in real option games, unifying various competitive frameworks and analyzing strategic interactions under uncertainty and risk aversion.

Findings

The model generalizes existing frameworks to include a randomized regulator.

Strategic interactions are fully characterized for different regulator parameters.

Uncertainty and risk aversion influence coordination and investment timing.

Abstract

We investigate a randomization procedure undertaken in real option games which can serve as a basic model of regulation in a duopoly model of preemptive investment. We recall the rigorous framework of [M. Grasselli, V. Lecl\`ere and M. Ludkovsky, Priority Option: the value of being a leader, International Journal of Theoretical and Applied Finance, 16, 2013], and extend it to a random regulator. This model generalizes and unifies the different competitive frameworks proposed in the literature, and creates a new one similar to a Stackelberg leadership. We fully characterize strategic interactions in the several situations following from the parametrization of the regulator. Finally, we study the effect of the coordination game and uncertainty of outcome when agents are risk-averse, providing new intuitions for the standard case.