IDEAS home Printed from https://ideas.repec.org/a/eee/dyncon/v84y2017icp1-31.html
   My bibliography  Save this article

Capacity expansion games with application to competition in power generation investments

Author

Listed:
  • Aïd, René
  • Li, Liangchen
  • Ludkovski, Michael

Abstract

We consider competitive capacity investment for a duopoly of two distinct producers. The producers are exposed to stochastically fluctuating costs and interact through aggregate supply. Capacity expansion is irreversible and modeled in terms of timing strategies characterized through threshold rules. Because the impact of changing costs on the producers is asymmetric, we are led to a nonzero-sum timing game describing the transitions among the discrete investment stages. Working in a continuous-time diffusion framework, we characterize and analyze the resulting Nash equilibrium and game values. Our analysis quantifies the dynamic competition effects and yields insight into dynamic preemption and over-investment in a general asymmetric setting. A case-study considering the impact of fluctuating emission costs on power producers investing in nuclear and coal-fired plants is also presented.

Suggested Citation

  • Aïd, René & Li, Liangchen & Ludkovski, Michael, 2017. "Capacity expansion games with application to competition in power generation investments," Journal of Economic Dynamics and Control, Elsevier, vol. 84(C), pages 1-31.
    • Handle: RePEc:eee:dyncon:v:84:y:2017:i:c:p:1-31
    DOI: 10.1016/j.jedc.2017.08.002
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0165188917301756
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jedc.2017.08.002?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Bar-Ilan, Avner & Sulem, Agnes & Zanello, Alessandro, 2002. "Time-to-build and capacity choice," Journal of Economic Dynamics and Control, Elsevier, vol. 26(1), pages 69-98, January.
    2. Takashima, Ryuta & Goto, Makoto & Kimura, Hiroshi & Madarame, Haruki, 2008. "Entry into the electricity market: Uncertainty, competition, and mothballing options," Energy Economics, Elsevier, vol. 30(4), pages 1809-1830, July.
    3. Kuno J.M. Huisman & Peter M. Kort, 2015. "Strategic capacity investment under uncertainty," RAND Journal of Economics, RAND Corporation, vol. 46(2), pages 376-408, June.
    4. Dixit, Avinash, 1995. "Irreversible investment with uncertainty and scale economies," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 327-350.
    5. Boyer, Marcel & Lasserre, Pierre & Moreaux, Michel, 2012. "A dynamic duopoly investment game without commitment under uncertain market expansion," International Journal of Industrial Organization, Elsevier, vol. 30(6), pages 663-681.
    6. Williams, Joseph T, 1993. "Equilibrium and Options on Real Assets," The Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 825-850.
    7. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    8. Aïd, René & Federico, Salvatore & Pham, Huyên & Villeneuve, Bertrand, 2015. "Explicit investment rules with time-to-build and uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 240-256.
    9. Jan-Henrik Steg, 2012. "Irreversible investment in oligopoly," Finance and Stochastics, Springer, vol. 16(2), pages 207-224, April.
    10. Fleten, S.-E. & Maribu, K.M. & Wangensteen, I., 2007. "Optimal investment strategies in decentralized renewable power generation under uncertainty," Energy, Elsevier, vol. 32(5), pages 803-815.
    11. Hanan Luss, 1982. "Operations Research and Capacity Expansion Problems: A Survey," Operations Research, INFORMS, vol. 30(5), pages 907-947, October.
    12. Bashyam, T. C. A., 1996. "Competitive capacity expansion under demand uncertainty," European Journal of Operational Research, Elsevier, vol. 95(1), pages 89-114, November.
    13. Azevedo, Alcino & Paxson, Dean, 2014. "Developing real option game models," European Journal of Operational Research, Elsevier, vol. 237(3), pages 909-920.
    14. Steven R. Grenadier, 2000. "Option Exercise Games: The Intersection Of Real Options And Game Theory," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(2), pages 99-107, June.
    15. Michail Chronopoulos & Verena Hagspiel & Stein-Erik Fleten, 2017. "Stepwise investment and capacity sizing under uncertainty," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 39(2), pages 447-472, March.
    16. Siddiqui, Afzal & Takashima, Ryuta, 2012. "Capacity switching options under rivalry and uncertainty," European Journal of Operational Research, Elsevier, vol. 222(3), pages 583-595.
    17. Joachim Gahungu and Yves Smeers, 2012. "A Real Options Model for Electricity Capacity Expansion," RSCAS Working Papers 2012/08, European University Institute.
    18. Said Hamadène & Monique Jeanblanc, 2007. "On the Starting and Stopping Problem: Application in Reversible Investments," Mathematics of Operations Research, INFORMS, vol. 32(1), pages 182-192, February.
    19. Tim Leung & Xin Li, 2015. "Optimal Mean Reversion Trading With Transaction Costs And Stop-Loss Exit," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(03), pages 1-31.
    20. repec:dau:papers:123456789/14292 is not listed on IDEAS
    21. Paxson, Dean & Pinto, Helena, 2005. "Rivalry under price and quantity uncertainty," Review of Financial Economics, Elsevier, vol. 14(3-4), pages 209-224.
    22. Dayanik, Savas & Karatzas, Ioannis, 2003. "On the optimal stopping problem for one-dimensional diffusions," Stochastic Processes and their Applications, Elsevier, vol. 107(2), pages 173-212, October.
    23. Kong, Jean J. & Kwok, Yue Kuen, 2007. "Real options in strategic investment games between two asymmetric firms," European Journal of Operational Research, Elsevier, vol. 181(2), pages 967-985, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Liangchen Li & Michael Ludkovski, 2018. "Stochastic Switching Games," Papers 1807.03893, arXiv.org.
    2. Ren'e Aid & Luciano Campi & Liangchen Li & Mike Ludkovski, 2020. "An Impulse-Regime Switching Game Model of Vertical Competition," Papers 2006.04382, arXiv.org.
    3. René Aïd & Luciano Campi & Liangchen Li & Mike Ludkovski, 2021. "An Impulse-Regime Switching Game Model of Vertical Competition," Dynamic Games and Applications, Springer, vol. 11(4), pages 631-669, December.
    4. Bichuch, Maxim & Hobbs, Benjamin F. & Song, Xinyue, 2023. "Identifying optimal capacity expansion and differentiated capacity payments under risk aversion and market power: A financial Stackelberg game approach," Energy Economics, Elsevier, vol. 120(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Sendstad, Lars Hegnes & Chronopoulos, Michail, 2017. "Strategic Technology Switching under Risk Aversion and Uncertainty," Discussion Papers 2017/10, Norwegian School of Economics, Department of Business and Management Science.
    2. Azevedo, Alcino & Paxson, Dean, 2014. "Developing real option game models," European Journal of Operational Research, Elsevier, vol. 237(3), pages 909-920.
    3. Michail Chronopoulos & Verena Hagspiel & Stein-Erik Fleten, 2017. "Stepwise investment and capacity sizing under uncertainty," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 39(2), pages 447-472, March.
    4. Randrianarisoa, Laingo M. & Zhang, Anming, 2019. "Adaptation to climate change effects and competition between ports: Invest now or later?," Transportation Research Part B: Methodological, Elsevier, vol. 123(C), pages 279-322.
    5. Sendstad, Lars Hegnes & Chronopoulos, Michail, 2021. "Strategic technology switching under risk aversion and uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 126(C).
    6. Kuno J.M. Huisman & Peter M. Kort, 2015. "Strategic capacity investment under uncertainty," RAND Journal of Economics, RAND Corporation, vol. 46(2), pages 376-408, June.
    7. Liu, Yu-Hong & Jiang, I-Ming, 2019. "Optimal proportion decision-making for two stages investment," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 776-785.
    8. Siddiqui, Afzal & Takashima, Ryuta, 2012. "Capacity switching options under rivalry and uncertainty," European Journal of Operational Research, Elsevier, vol. 222(3), pages 583-595.
    9. Adkins, Roger & Paxson, Dean, 2019. "Rescaling-contraction with a lower cost technology when revenue declines," European Journal of Operational Research, Elsevier, vol. 277(2), pages 574-586.
    10. Liangchen Li & Michael Ludkovski, 2018. "Stochastic Switching Games," Papers 1807.03893, arXiv.org.
    11. Alcino Azevedo & Dean Paxson, 2018. "Rivalry and uncertainty in complementary investments with dynamic market sharing," Annals of Operations Research, Springer, vol. 271(2), pages 319-355, December.
    12. Chronopoulos, Michail & De Reyck, Bert & Siddiqui, Afzal, 2014. "Duopolistic competition under risk aversion and uncertainty," European Journal of Operational Research, Elsevier, vol. 236(2), pages 643-656.
    13. Michail Chronopoulos, Derek Bunn, and Afzal Siddiqui, 2014. "Optionality and Policymaking in Re-Transforming the British Power Market," Economics of Energy & Environmental Policy, International Association for Energy Economics, vol. 0(Number 2).
    14. Balliauw, Matteo & Kort, Peter M. & Zhang, Anming, 2019. "Capacity investment decisions of two competing ports under uncertainty: A strategic real options approach," Transportation Research Part B: Methodological, Elsevier, vol. 122(C), pages 249-264.
    15. Arasteh, Abdollah, 2017. "Considering the investment decisions with real options games approach," Renewable and Sustainable Energy Reviews, Elsevier, vol. 72(C), pages 1282-1294.
    16. Guthrie, Graeme, 2020. "Investment flexibility as a barrier to entry," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    17. Manuel Guerra & Cláudia Nunes & Carlos Oliveira, 2021. "The optimal stopping problem revisited," Statistical Papers, Springer, vol. 62(1), pages 137-169, February.
    18. Balter, Anne G. & Huisman, Kuno J.M. & Kort, Peter M., 2022. "Effects of creative destruction on the size and timing of an investment," International Journal of Production Economics, Elsevier, vol. 252(C).
    19. Billette de Villemeur, Etienne & Ruble, Richard & Versaevel, Bruno, 2014. "Investment timing and vertical relationships," International Journal of Industrial Organization, Elsevier, vol. 33(C), pages 110-123.
    20. Billette de Villemeur, Etienne & Ruble, Richard & Versaevel, Bruno, 2014. "Innovation and imitation incentives in dynamic duopoly," MPRA Paper 59453, University Library of Munich, Germany.

    More about this item

    Keywords

    Capacity expansion; Continuous-time games of timing; Non-zero-sum stopping games; Power generation investments;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • Q40 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:84:y:2017:i:c:p:1-31. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jedc .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.