Primary target field: industrial organization Secondary target field: financial economics, game theory Paper: Exit in duopoly under uncertainty Thesis: On investment, uncertainty, and strategic interaction with applications in energy markets Pauli Murto

Problem analyzed: There is uncertainty on the developments of industries; markets fluctuate: demand shifts, technological expectations fail, etc. When the market declines, it may become optimal for a firm to exit The problem is related but opposite to the optimal investment problem When considered in isolation from competition, the optimal timing of exit is straight-forward to solve using the same methodology as investment However, when there are many firms in the industry, the exit of a given firm affects the profitability of the remaining ones This results in a strategic interaction, where the firms would typically like to see their competitors exit as early as possible What is their Nash-equilibrium exit pattern? When do they exit and who exits first? How does uncertainty affect the equilibrium?

Background literature: Literature on real options: –Exit without strategic interaction: uncertainty increases reluctancy to exit –Some new literature on entry games with uncertainty: opposite strategic interaction to exit Industrial organization literature: –Exit with the focus on strategic interaction, but no uncertainty –Unique sub-game perfect equilibrium exit pattern with asymmetric firms: the large firm exits before the small firm Stopping game literature: –Some results on specific classes of continuous time stopping games exist, but none directly applicable to the present case This paper combines these literatures to consider exit under both uncertainty and strategic interaction

Results: The incorporation of uncertainty requires a refined definition of strategies compared to the deterministic IO models: Markov strategies Some results from the IO literature carry over to the stochastic market: e.g.: unique sub-game perfect equilibrium exit pattern with low degree of uncertainty However, subgame perfectness criterion may suddenly lose its effect when uncertainty is increased beyond some point! The contribution can be seen from two angles: –Extension of the real options theory to consider abandonment options in oligopoly –Extension of the theory of industrial organization to consider market stability as one of the factors explaining the firms’ behavior Also a new result in the theory of stopping games

Publication plan : Under review in the RAND Journal of Economics since 1/2002 First answer in 5/2002: –Too long and technical for the journal –One of the referees doubts some results –Contribution considered important by both referees and the editor –Thorough and qualified reports Revision submitted in 8/2002: –Considerably shortened –Presentation of the results simplified –All referees’ comments addressed Report from the thesis examinors in 11/2002: –Significance of the questions analyzed should be better justified and interpretation of the results should be strengthened Current plan: –Minor revisions according to the comments of the thesis examinors –Waiting for the answer from the journal