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The authors model a two-stage R&D project with an abandonment option. Two types of uncertainty influence the decision to start R&D. Demand uncertainty is modeled as a lottery between a proportional increase and decrease in demand. Technical uncertainty is modeled as a lottery between a decrease and increase in the cost to continue R&D. Both lotteries become more divergent when the difference between the outcomes of the lottery increases. A potential entrant is endowed with a superior technology and threatens to drive the incumbent out of the market. The incumbent has a time lead over the entrant and can obtain the same superior technology by completing the R&D project before the entrant can enter the market.
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