A Duopoly Real Option Model with Capacity Competition

Abstract

This paper examines strategic decisions by the firms who want to develop a new building in a real estate market with uncertainty and duopoly competition. Compared to earlier “option-game” models which only consider the timing of investment, our model also considers the capacity of the development at the same moment. We analyze two kinds of models on the capacity competition. In a leader-follower game the leader will preempt the follower at the moment where the leader's value is equalized to the followers', consequently the Stackelberg equilibrium capacities of real estate development are decided. In contrast, the firms face a Cournot competition when they decide to develop a real estate simultaneously.