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Valuing investment project in competitive environment

Pages: 945 - 950, Issue Special, July 2003

 Abstract        Full Text (151.2K)              

Ming Yang - Dept. of Mathematics, Huazhong University of Science and Technology, Wuhan(430074), Hubei, China (email)
Chulin Li - Dept. of Mathematics, Huazhong University of Science and Technology, Wuhan(430074), Hubei, China (email)

Abstract: This paper provides a model of investment project in a dynamic competitive environment and values the system. The option value of the investment is modelled as a solution of a stochastic differential equation with free boundary through a combination of real option approach as well as dynamic investing analysis. The optimal investment rule is the free boundary of the equation, $p$*, such that the firm invests at once when $p \>= p$* and waits when $p < p$*. The result shows how uncertainty in project and competitive pressure of a rival affect the value of the project and firm’s investment behavior. The results imply that the investment option value of following investor will be valueless when the research effort intensity of the leader investor is larger enough. The results demonstrate that the model can be applied as an extension from those discussing value of real options for a non -competitive environment.

Keywords:  Value of project, investment, free boundary problem.
Mathematics Subject Classification:  Primary: 58J90, 65N99; Secondary: 91A05, 91A25 91A35.

Received: August 2002;      Revised: April 2003;      Published: April 2003.