Strategic Irreversible Investment

TL;DR

This paper analyzes oligopolistic irreversible investment using dynamic closed-loop strategies, revealing how strategic interactions influence preemption incentives and equilibrium outcomes.

Contribution

It introduces a novel Markov perfect equilibrium concept for singular control investment strategies in oligopolies, capturing richer strategic behavior.

Findings

Closed-loop strategies enable credible reactions and deter preemption.

Simpler strategies can lead to a preemption trap with competitive outcomes.

The new equilibrium concept handles optimal investment as singular control.

Abstract

This paper studies oligopolistic irreversible investment with closed-loop strategies. These permit fully dynamic interactions that result in much richer strategic behavior than previous studies with open-loop strategies allow. The tradeoff between preemption incentives and the option value of waiting becomes distinctly visible. Strategies that depend on present capital stocks enable credible reactions that deter from excessive preemption and support positive option values in equilibrium. Simpler strategies lead into a "preemption trap" with perfectly competitive outcome and zero net present values. To obtain these results, a novel concept of Markov perfect equilibrium is developed that copes with optimal investment taking the form of singular control.