Application of Option Games in Investment Analysis

Document Type: ICIE 2016


Babol Noshirvani University of Technology, Babol, Iran


This paper considers a popular problem in the investment, the best time and size of investment, using methods of real options in a cooperative game setting. Moreover, it shows a combination of real option theory to invest, combined with a competitive game between two movers in the growth of a general-use asset and cooperative game theory between two movers to catch a network effect. In the model, two firms have similar and interacting investment opportunities. There is a real option for both firms to postpone the investment until they have proper price and production states. There are benefits to a first mover who can create a facility to its own conditions. Also, there is a useful network effect of operating synergy if the first mover successfully motivates the second mover to start production instantaneously by sharing the production facility. So, the first mover has to discover when to create, what capacity to create and what the best economic rent is for using the facility. The second mover has to discover whether to use the first mover’s facility or create its own facility, and if it discovers to create it owns, what better time and size are.


Main Subjects

Agaton, C.B. and H. Karl. (2018). A real options approach to renewable electricity generation in the Philippines. Energy, Sustainability and Society, Vol. 8(1), pp.1-9.

Aguerrevere, F.L. (2003). Equilibrium investment strategies and output price behavior: A real-options approach. The Review of Financial Studies, Vol. 16(4), pp. 1239-1272.

Anshelevich, E., F.B. Shepherd, and G. Wilfong (2011). Strategic network formation through peering and service agreements. Games and Economic Behavior, Vol. 73(1), pp. 17-38.

Antoniadou, E., C. Koulovatianos, and L.J. Mirman (2013). Strategic exploitation of a common-property resource under uncertainty. Journal of Environmental Economics and Management, Vol. 65(1), pp. 28-39.

Gutirrez, O., and Ruiz-Aliseda, F. (2011). Real Options with Unknown-Date Events. Annals of Finannce, Vol. 7(2), pp. 171-198.

Ash, K., (2011). A game-theoretic model for protest in the context of post-communism. Communist and Post-Communist Studies, Vol. 44(1), pp. 1-15.

Asteriadis, S., et al. (2012). Towards Detecting Clusters of Players using Visual and Gameplay Behavioral Cues. Procedia Computer Science, Vol. 15(0), pp. 140-147.

Azevedo, A. and D. Paxson (2009). Uncertainty and Competition in the Adoption of Complementary Technologies, International Real Options Conference.

Barth, A.L. and W. de Beer (2018). Performance Management Process: Considerations and Options, Performance Management Success, pp. 115-119, Springer, Cham.

Benaroch, M. (2018). Real Options Models for Proactive Uncertainty-Reducing Mitigations and Applications in Cybersecurity Investment Decision Making. Information Systems Research, Doi: 10.1287/isre.2017.0714.

Bensoussan, A., et al. (2017), Real options with competition and regime switching. Mathematical Finance, Vol. 27(1), pp. 224-250.

Bester, H. and D. Krähmer (2012). Exit options in incomplete contracts with asymmetric information. Journal of Economic Theory, Vol. 147(5), pp. 1947-1968.

Bouis, R., K.J. Huisman, and P.M. Kort, Strategic real options: three firms. 2005.

Briglauer, W. and I. Vogelsang (2011). The need for a new approach to regulating fixed networks. Telecommunications Policy, Vol. 35(2), pp. 102-114.

Bulan, L., C. Mayer, and C.T. (2009). Somerville, Irreversible investment, real options, and competition: Evidence from real estate development. Journal of Urban Economics, Vol. 65(3), pp. 237-251.

Capozza, D.R. and G.A. Sick (1991). Valuing long-term leases: The option to redevelop. The Journal of Real Estate Finance and Economics, Vol. 4(2), pp. 209-223.

Chen, X. and G. Hao (2013). Co-opetition alliance models of parallel flights for determining optimal overbooking policies. Mathematical and Computer Modelling, Vol. 57(5–6), pp. 1101-1111.

Décamp, J.-P. and T. Mariotti (2004). Investment timing and learning externality. Journal of Economic Theory, Vol. 18(80-102), pp. 5-xx.

Décamps, J.-P. and T. Mariotti (2004). Investment timing and learning externalities. Journal of Economic Theory, Vol. 118(1), pp. 80-102.

Deutsch, Y., B. Golany, and U.G. Rothblum (2011). Determining all Nash equilibria in a (bi-linear) inspection game. European Journal of Operational Research, Vol. 215(2), pp. 422-430.

Dixit, A.K. and R.S. Pindyck (1994). Investment under uncertainty, USA: Princeton university press.

Dixit, A.K. and R.S. Pindyck (1995). The options approach to capital investment. Real Options and Investment under Uncertainty-classical Readings and Recent Contributions. USA: MIT Press, Cambridge, 6.

Epstein, L., et al., (2013). Approximate strong equilibria in job scheduling games with two uniformly related machines. Discrete Applied Mathematics, Vol. 161(13–14), pp. 1843-1858.

Favato, G. and R. Vecchiato (2017). Embedding real options in scenario planning: A new methodological approach. Technological Forecasting and Social Change, Vol. 124, pp. 135-149.

Feri, F. and A. Gantner (1985). Bargaining or searching for a better price? – An experimental study. Games and Economic Behavior, Vol. 72(2), pp. 376-399.

Fudenberg, D. and J. Tirole (1985). Preemption and rent equalization in the adoption of new technology. The Review of Economic Studies, Vol. 52(3), pp. 383-401.

Garlappi, L., V. Naik, and J. Slive (2001). Portfolio selection with multiple assets and capital gains taxes, (July, 2011).

Godinho, P. and J. Dias (2013). Two-player simultaneous location game: Preferential rights and overbidding. European Journal of Operational Research, Vol. 229(3), pp. 663-672.

Grenadier, S., (1996). The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets. Journal of Finance, Vol. 51, pp. 1653-1679.

Grenadier, S.R., (2000). Option exercise games: The intersection of real options and game theory. Journal of Applied Corporate Finance, Vol. 13(2), pp. 99-107.

Grenadier, S.R., (2002). Option exercise games: An application to the equilibrium investment strategies of firms. The Review of Financial Studies, Vol. 15(3), pp. 691-721.

Grullon, G., E. Lyandres, and A. Zhdanov (2012). Real options, volatility, and stock returns. The Journal of Finance, Vol. 67(4), pp. 1499-1537.

Halpern, J.Y. and L.C. Rêgo (2014). Extensive games with possibly unaware players. Mathematical Social Sciences, (0). Vol. 70, pp. 42-58.

Hsu, Y.-W. and B. Lambrecht (2003). Preemptive patenting under uncertainty and asymmetric information.  International Real Options Conference. Washington DC, pp. 1-38.

Huisman, K. (2001). Technology Investment: A Game Theoretic Real Options Approach, Dordrecht, Netherlands: Klumer Academic Publishers.

Huisman, K. and P. Kort (2003). Strategic Investment in Technological Innovations. European Journal of Operational Research, Vol. 144, pp. 209-223.

Huisman, K. and P. Kort (2004). Strategic Technology Adoption taking into account Future Technological Improvements: A Real Options Approach. European Journal of Operational Research, Vol. 159, pp. 705-728.

Huisman, K.J. and P.M. Kort (2004). Strategic technology adoption taking into account future technological improvements: A real options approach. European Journal of Operational Research, Vol. 159(3), pp. 705-728.

Huisman, K.J., et al. (2004). Strategic investment under uncertainty: Merging real options with game theory, Real Options. Springer. p. 97-124.

Huisman, K.J. (2013). Technology investment: A game theoretic real options approach. Vol. 28, Springer Science & Business Media.

Igartua, M.A., et al. (2011). A game-theoretic multipath routing for video-streaming services over Mobile Ad Hoc Networks. Computer Networks, Vol. 55(13), pp. 2985-3000.

Ishii, M., et al. (2013), A game theoretical analysis of port competition. Transportation Research Part E: Logistics and Transportation Review, Vol. 49(1), pp. 92-106.

Jeuland, M. and D. Whittington (2014). Water resources planning under climate change: Assessing the robustness of real options for the Blue Nile. Water Resources Research, Vol. 50(3), pp. 2086-2107.

Jin, N. and E. Tsang (2011). Bargaining strategies designed by evolutionary algorithms. Applied Soft Computing, Vol. 11(8), pp. 4701-4712.

Kong, J. and Y. Kwon (2007). Real Options in Strategic Investment Games between two Asymmetric Firms. European Journal of Operational Research, Vol. 18, pp. 967-985.

Kort, P.M., P. Murto, and G. Pawlina (2004). The value of flexibility in sequencing growth investment. in Real Options: Theory Meets Practice, 8 th Annual International Conference, Montreal. Citeseer.

Kulas, J.T., M. Komai, and P.J. Grossman (2013). Leadership, information, and risk attitude: A game theoretic approach. The Leadership Quarterly, Vol. 24(2), pp. 349-362.

Kulatilaka, N. and E.C. Perotti (1998). Strategic growth options. Management Science, Vol. 44(8), pp. 1021-1031.

Lambrecht, B. and W. Perraudin (2003). Real options and preemption under incomplete information. Journal of Economic dynamics and Control, Vol. 27(4), pp. 619-643.

Leung, C.M. and Y.K. Kwok (2012). Patent-investment games under asymmetric information. European Journal of Operational Research, Vol. 223(2), pp. 441-451.

Li, D.-F., (2011). Linear programming approach to solve interval-valued matrix games. Omega, Vol. 39(6), pp. 655-666.

Mæland, J. (2002) Asymmetric Information and Irreversible Investments: Competing Agents. 6th Annual International Conference on Real Options, Coral Beach, Paphos Cyprus.

Manapat, M.L., M.A. Nowak, and D.G. Rand (2013), Information, irrationality, and the evolution of trust. Journal of Economic Behavior & Organization, Vol. 90, pp. S57-S75.

Mason, R. and H. Weeds (2005). The timing of acquisitions. University of Southampton and University of Essex.

Mejia, M., et al., (2011). A game theoretic trust model for on-line distributed evolution of cooperation inMANETs. Journal of Network and Computer Applications, Vol. 34(1), pp. 39-51.

Merton, R.C., M.J. Brennan, and E.S. Schwartz (1977). The valuation of American put options. The Journal of Finance, Vol. 32(2), pp. 449-462.

Milanés, V., et al. (2014). Cooperative adaptive cruise control in real traffic situations. IEEE Transactions on Intelligent Transportation Systems, Vol. 15(1), pp. 296-305.

Murto, M., L. Björnsson, and B. Mattiasson (2004), Impact of food industrial waste on anaerobic co-digestion of sewage sludge and pig manure. Journal of environmental management, Vol. 70(2), pp. 101-107.

Murto, P. and J. Keppo (2002). A game model of irreversible investment under uncertainty. International Game Theory Review, Vol. 4(02), pp. 127-140.

Nielsen, M.J., (2002). Competition and irreversible investments. International Journal of Industrial Organization,Vol. 20(5), pp. 731-743.

Odening, M., et al. (2007). Investment under uncertainty—Does competition matter? Journal of Economic Dynamics and Control, Vol. 31(3), pp. 994-1014.

Odening, M., O. Mußhoff, and W. Xu (2007). Analysis of rainfall derivatives using daily precipitation models: Opportunities and pitfalls. Agricultural Finance Review, Vol. 67(1), pp. 135-156.

Parag, Y., et al. (2013), Network approach for local and community governance of energy: The case of Oxfordshire. Energy Policy, Vol. 62, pp. 1064-1077

Pavlova, Y. and G. Reniers (2011). A sequential-move game for enhancing safety and security cooperation within chemical clusters. Journal of Hazardous Materials, Vol. 186(1), pp. 401-406.

Pawlina, G. and P. Kort (2006). Real Options in an Asymmetric Duopoly: Who Benefits from your Competitive Disadvantage? Journal of Economics & Management Strategy, Vol. 15, pp. 1-35.

Paxson, D. and H. Pinto (2005). Rivalry under Price and Quantity Uncertainty. Review of Financial Economics, Vol. 14, pp. 209-224.

Rau, P. and S. Spinler (2016). Investment into container shipping capacity: A real options approach in oligopolistic competition. Transportation Research Part E: Logistics and Transportation Review, Vol. 93, pp. 130-147.

Rivas, M.F. and M. Sutter (2011). The benefits of voluntary leadership in experimental public goods games. Economics Letters, Vol. 112(2), pp. 176-178.

Rosenberg, D., A. Salomon, and N. Vieille (2013). On games of strategic experimentation. Games and Economic Behavior, Vol. 82, pp. 31-51.

Said, M., (2011). Sequential auctions with randomly arriving buyers. Games and Economic Behavior, Vol. 73(1), pp. 236-243.

Savolainen, J., M. Collan, and P. Luukka (2017). Analyzing operational real options in metal mining investments with a system dynamic model. The Engineering Economist, Vol. 62(1), pp. 54-72.

Savva, N. and S. Scholtes (2005). Real options in partnership deals: The perspective of cooperative game theory. Real Options Conference.

Scharpf, F.W., (2018). Games real actors play: Actor-centered institutionalism in policy research. UK: Routledge.

Shackleton, C. and S. Shackleton (2004). The importance of non-timber forest products in rural livelihood security and as safety nets: a review of evidence from South Africa. South African Journal of Science, Vol. 100(11-12), pp. 658-664.

Shackleton, M.B., A.E. Tsekrekos, and R. Wojakowski (2004). Strategic entry and market leadership in a two-player real options game. Journal of banking & finance, Vol. 28(1), pp. 179-201.

Sick, G., (1995). Real options. Handbooks in operations research and management science, Vol. 9, pp. 631-691.

Sick, G. and Y. Li (2007). Real options, sequential bargaining game and network effects in natural gas production.

Singh, A. (2012). An overview of the optimization modelling applications. Journal of Hydrology, Vol. 466–467(0), pp. 167-182.

Smala Fanokoa, P., I. Telahigue, and G. Zaccour (2011). Buying cooperation in an asymmetric environmental differential game. Journal of Economic Dynamics and Control, Vol. 35(6), pp. 935-946.

Smets, F. (1993). Essays on foreign direct investment. , Yale University.

Smit, H. and L. Trigeorgies (2004). Strategic Investment: Real Options and Games. New Jersey: Princeton University Press.

Smit, H. and L. Trigeorgies (2006). Real Options and Games: Competition, Alliances and other Applications of Valuation and Strategy. Review of Financial Economics, Vol. 15, pp. 95-112.

Smit, H.T. and L. Trigeorgis (2004). Quantifying the strategic option value of technology investments. Montreal: 8th Annual International Real Options Theory.

Thijssen, J.J., K.J. Huisman, and P.M. Kort (2012). Symmetric equilibrium strategies in game theoretic real option models. Journal of Mathematical Economics, Vol. 48(4), pp. 219-225.

Thijssen, J.J.J., K.J.M. Huisman, and P.M. Kort (2012). Symmetric equilibrium strategies in game theoretic real option models. Journal of Mathematical Economics, Vol. 48(4), pp. 219-225.

Trigeorgis, L. (1996). Real options: Managerial flexibility and strategy in resource allocation. USA: MIT press.

Wang, J., C.-Y. Wang, and C.-Y. Wu (2015). A real options framework for R&D planning in technology-based firms. Journal of Engineering and Technology Management, Vol. 35, pp. 93-114.

Weeds, H. (2002). Strategic Delay in a Real Options Model of R&D Competition. Review of Economic Studies, Vol. 69, pp. 729-747.

Wesseh Jr, P.K. and B. Lin (2016). A real options valuation of Chinese wind energy technologies for power generation: do benefits from the feed-in tariffs outweigh costs? Journal of Cleaner Production, Vol. 112, pp. 1591-1599.

Weyant, J. and T. Yao (2005). Strategic R&D Investment under Uncertainty in Information Technology: Tacit Collusion and Information Time Lag. Real Options Conference.

Wolbert-Haverkamp, M. and O. Musshoff (2014). Are short rotation coppices an economically interesting form of land use? A real options analysis. Land Use Policy, Vol. 38, pp. 163-174.

Wu, M.-C. and C.-Y. (2006). Tseng, Valuation of patent–a real options perspective. Applied Economics Letters, Vol. 13(5), pp. 313-318.

Zheng, X. and Y. Cheng (2011). Conflict game in evacuation process: A study combining Cellular Automata model. Physica A: Statistical Mechanics and its Applications, Vol. 390(6), pp. 1042-1050.