Leaders, Followers, And Risk Dynamics In Industry Equilibrium

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Executive Summary

The authors study own and rival risk in a dynamic duopoly with a homogeneous output good, stochastic industry demand, and real options to expand or contract capacity. They focus on asymmetric cost functions and sequential option exercise. In general, a competitor's options to adjust capacity reduce own-firm risk. Intuitively, improvements in the product market bring the offsetting bad news that rival expansion is nearer. Similarly, negative demand shocks are counterbalanced by an increased likelihood of competitor contraction in the near future.

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