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RFS Advance Access originally published online on July 8, 2009
Review of Financial Studies 2009 22(11):4531-4552; doi:10.1093/rfs/hhp046
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© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org.

Open-Loop Equilibria and Perfect Competition in Option Exercise Games

Kerry Back
Texas A&M University

Dirk Paulsen
University of Bonn

Send correspondence to Kerry Back, Jesse H. Jones Graduate School of Business, Rice University, 6100 Main Street, Houston, TX 77252; telephone: +713-348-5928; Fax: +713-348-5110. E-mail: kerryback{at}gmail.com

JEL Classification: C73, D43, D92, G31, L13


  Abstract

The investment boundaries defined by Grenadier (2002) for an oligopoly investment game determine equilibria in open-loop strategies. As closed-loop strategies, they are not equilibria, because any firm by investing sooner can preempt the investments of other firms and expropriate the growth options. The perfectly competitive outcome is produced by closed-loop strategies that are mutually best responses. In this equilibrium, the option to delay investment has zero value, and the simple NPV rule is followed by all firms.

We thank Shmuel Baruch, Steve Grenadier, Steve Heston, Mark Loewenstein, Leonid Kogan, Bob McDonald, Jacob Sagi, and especially Frank Riedel for helpful advice on this work.


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