Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms

Under the standard real options approach to investment under uncertainty, agents formulate optimal exercise strategies in isolation and ignore competitive interactions. However, in many real-world asset markets, exercise strategies cannot be determined separately, but must be formed as part of a strategic equilibrium. This article provides a tractable approach for deriving equilibrium investment strategies in a continuous-time Cournot–Nash framework. The impact of competition on exercise strategies is dramatic. For example, while standard real options models emphasize that a valuable “option to wait” leads firms to invest only at large positive net present values, the impact of competition drastically erodes the value of the option to wait and leads to investment at very near the zero net present value threshold.