Investment under uncertainty - Does competition matter?

Empirical applications of real options models in competitive environments implicitly exploit the optimality of myopic planning. In a seminal paper [Leahy, J.V., 1993. Investment in Competitive Equilibrium: the Optimality of Myopic Behavior. Quarterly Journal of Economics 108, 1105-1133] shows that the optimal investment strategy of a myopic planner who ignores market entries and exits of competitors, as well as the resulting price effects, constitutes a market equilibrium under rather general conditions. As a result, the calculation of optimal investment strategies is simplified considerably because competition does not have to be taken into account. In this paper, however, we demonstrate by using simulation experiments that myopic planning may lead to non-optimal investment strategies. This is due to the fact that it is difficult, or even impossible, to specify the correct or equivalent price process for the myopic investor using real world data. We quantify the degree of suboptimality and propose measures to reduce the error. (C) 2006 Elsevier B.V. All rights reserved.