A Game Theoretic Real Option Model for Strategic Decision on R&D and Commercialization Considering Uncertain Technology and Market

Abstract

In this paper, we analyze the strategic investment decision problem considering the uncertainty of not only technology but also market demand using a two-stage game-theoretic real option model. In the first stage two firms compete with R&D investment by which the firm can enter a new market according to the success or failure of R&D. And then in the second stage, the both firms decide whether to enter the market or postpone until the demand uncertainty would be resolved. The payoff functions are formulated by using a binomial real options model to incorporate the technological and market uncertainty. As a result, we found the Bayesian Nash equilibrium which characterizes the optimal investment decision strategies for both companies, which can be used to calculate the optimal level of profits. Numerical experiments with graphical illustrations are presented to demonstrate the optimality of strategies whereby the two firms maximize their own profits. In addition, on the basis of the results of optimal profits and strategies, the present study performs sensitivity analysis with regard to various exogenous variables that could affect the profits and strategies.