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Rivalry restraint has received a lot of attention as a theory of profits in recent research on business strategy. Its economic rationale is explained as the consequences of either exogenous or endogenous anticompetitive forces present in different industries. In this paper, we use a dynamic oligopolistic industry model and show that rivalry restraint emerges as equilibrium behavior among firm owners who delegate decisions to managers. In the corresponding two-stage game, managers choose optimal production rates in a dynamic Cournot market and owners set incentives for managers, acting sequentially rational. Equilibrium incentives correspond to rivalry restraint, that is, managers are less aggressive in the product market with lower outputs and increasing profits for all firms in the industry.

Standard option-based approximations for convenience yields make use of the assumption that commodity spot prices follow a geometric Brownian motion. While there is some empirical support for this assumption, prices of a wide variety of (agricultural) commodities mean revert. Using a mean-reverting spot price process we derive a novel convenience yield approximation analytically. It corresponds to the difference between the present values of two floating-strike Asian options written on the spot and the futures prices, respectively. Using natural gas spot and futures price data from four different trading locations, we compare convenience yield estimates derived from existing approximations to those of our new measure. We find that convenience yield estimates vary substantially across approximation methods and that differences can be attributed to the cost of carry and the moneyness of the options. © 2014 Wiley Periodicals, Inc. Jrl Fut Mark 35:625–654, 2015

Many economic problems can be formulated as dynamic games in which strategically interacting agents choose actions that determine the current and future levels of a single capital stock. We study necessary as well as sufficient conditions that allow us to characterise Markov perfect Nash equilibria for these games. These conditions can be translated into an auxiliary system of ordinary differential equations that helps us to explore stability, continuity and differentiability of these equilibria. The techniques are used to derive detailed properties of Markov perfect Nash equilibria for several games including voluntary investment in a public capital stock, the inter-temporal consumption of a reproductive asset and the pollution of a shallow lake.

Decentralized decision making is a fact in the modern business world accompanied by extensive research that looks into its consequences for overall firm profits. We study the interactions of decentralized marketing and operations divisions in a corporation and explore their impact on overall firm profits in the case with and without coordination of the two decentralized units. We assume that the marketing department is responsible for the price that influences the demand (sales), and the operations department is responsible for the production rate. We allow for backlogging over time. We model the interdependence involving marketing and operations decisions as a non-cooperative differential game, with the two divisions as strategically interacting players. We find that, without coordination, strategic interactions of marketing and production result in inefficiencies that can quantitatively be substantial. Next, we introduce a dynamic transfer pricing scheme as a coordination device and evaluate if it establishes efficient (first best and fully coordinated) outcomes. We show that if production and marketing play a game with pre-commitment strategies, there exists a dynamic transfer price that efficiently (fully) coordinates decentralized decision making and hence results in Pareto-efficient company profits. If the two decentralized divisions play a game without pre-commitment, dynamic transfer prices can partially coordinate decentralized decision making but fail to fully eliminate overall inefficiencies arising from strategic interactions among decentralized divisions.

With the liberalization of energy markets integrated energy companies have separated into entities that specialize in production and/or transmission of energy. Transmission of energy requires balancing the grid to guarantee system security, which is performed by the (independent) system operator (SO). When the SO faces stochastic demand, grid balancing has sizeable consequences on current and future profits, and hence, on firm value and firm risk. We explore these value and risk consequences with and without an investment option to expand transmission capacity. We show that firm value consists of the value of the transmission capacity in place plus the value of a short put and a short call option that are the result of the SO's balancing actions. Firm risk without investment option is non-linear and determined by the short option positions. It is decreasing with increasing energy demand. The existence of an option to expand transmission capacity increases firm value and firm risk.

We analyze in a dynamic model how debt priority rules influence firms' initial capital structure choice, investment timing, and subsequent debt issues. We quantify deviations from first-best investment behavior that arise from different debt priority rules, and document surprisingly large deviations caused by well-known rules such as the absolute priority rule. We introduce a new rule, called the efficient priority rule (EPR), that gives equity holders incentives to choose first-best investment timing and financing. Under EPR, old debt has the same value and risk characteristics as if the firm had not invested and new debt had not been issued.

We study the dynamics of an oligopolistic industry in which N firms produce a homogenous product and strategically invest in physical capital. Firms play a Markov game for which we derive equilibrium investment strategies. Since we assume nonlinear demand and cost structures, analytical results can only be found for a special case of our model. General insights into equilibrium investment strategies are derived through a numerical solution procedure. Using a projection method, we compute investment policy functions for different adjustment costs associated with capacity expansion. Equilibrium strategies are characterized by two distinct effects. First, there is a deterrence effect, i.e. firms decrease their investment levels with an increase in the rivals' capital stocks. Second, there is a preemptive role of capital. Firms overinvest and build up a large stock of capacity to deter the rival from expanding.

FNEGE 2, HCERES A, ABS 3; International audience; This paper studies investment in intellectual capital and corresponding value and risk dynamics over the innovation cycle. We assume that the innovation cycle consists of three phases, R&D, trial, and market introduction phases. We use a real option investment model to characterize firm value and risk dynamics over the innovation cycle and find that firm value is the sum of the value of assets in place and non-linear option values related to breakthrough, exit, and market introduction options. Firm risk over the innovation cycle is highly non-linear and quite distinct in different phases. During the R&D phase risk is high as the firm faces high operating leverage originating from R&D fixed costs together with technological uncertainty. During the trial phase risk is significantly lower and dominated by option risk to launch the product in the market while after the introduction of the product in the market risk is equivalent to the asset risk of the company. Our model is consistent with the view that positive excess returns of R&D intensive firms are a compensation for risk. Based on this insight we derive several testable predictions.

We consider an economy with a single capital stock that two agents strategically exploit by choosing a consumption profile over an infinite time horizon. We analyze two different games and their corresponding equilibria. In one game firms are able to pre-commit and choose simple time functions as their strategies. In the other game agents are assumed to employ Markov strategies. It turns out that in the case of pre-commitment there exists a threshold level of the capital stock such that if the initial stock is above this threshold, equilibrium consumption converges to the efficient steady state while if the initial condition is below it, the capital stock converges to zero. In case of the Markov equilibrium there exists a unique interior steady state that is globally stable.

Defining speed of diffusion as the amount of time it takes to get from one penetration level to a higher one, we introduce a dynamic model in which we study the link between pricing policy, speed of diffusion, and number of competitors in the market. Our analysis shows that, in the case of strategic (oligopolistic) competition, the speed of diffusion has an important influence on the optimal pricing policy. In particular, we find that higher speeds of diffusion create an incentive to strategically interacting firms to lower their prices.

The consequences of horizontal mergers on firms’ profits are traditionally studied within a static Cournot framework. In such a setting, the merger is modeled as an exogenous change in market structure. One of the key results in this literature is that if firms compete in a homogeneous product market, mergers will in general be unprofitable to the merging firms. In this paper, we analyze horizontal mergers of firms that compete in a dynamic Cournot market. We find unlike in static Cournot models that mergers are always profitable independent of the number of merging firms. While firms have an incentive to merge, welfare in the economy, however, does not increase since the gain in producer surplus does not offset the loss in consumer surplus due to increased prices.

Leitmann (Ref. 1) introduced coordinate transformations to derive global optima of a class of dynamic optimization problems. We present applications of this method to derive open-loop Nash equilibria for finite-time horizon differential games. The method of coordinate transformations is especially useful in cases where the original game does not satisfy the global curvature conditions normally imposed in sufficient optimality conditions.

Based on a classical financial market model we discuss three model variants, each focusing on a different approach in the formation of (heterogeneous) beliefs about future asset prices: the concept of Consistent Expectations, the concept of Adaptive Belief Systems, and artificial financial markets, where beliefs (or expectations) are formed by Classifier Systems. We analyze the consequences of these different mechanisms of expectations formation on the equilibrium dynamics of asset prices and compare statistical properties of returns generated by these models with the characteristics of real world time series.

We formulate a class of N player difference games and derive open—loop and Markov equilibria. It turns out that both types of equilibria can be characterized by a set of difference equations that describe the equilibrium dynamics. We analyze the stability properties of the difference equations that correspond to an equilibrium and find that in both the open—loop and the Markov game there is convergence towards a steady state equilibrium

While many marketing models ignore the influence of financial variables on a firm's marketing strategy, this article explores the effect of debt on the profit maximizing price for a new product. We assume a duopolistic market structure in which two firms produce a heterogeneous new consumer durable that is sold over two different periods. Firms know market demand in the first period with certainty, while demand in the second period is uncertain. Moreover, firms have free access to the capital market and finance part of their operating costs by issuing long-term debt. In this setting, we study the influence of long-term debt on firms' pricing policies. It turns out that leveraged firms compared to unleveraged ones have different pricing strategies. In particular, first-period prices are lower and second-period prices are higher in case of long-term debt than in the case of no leverage. Finally we find that prices for firms that take on debt are less volatile than prices for purely equity-financed firms.

The search for deterministic chaos in economic and financial time series has attracted much interest over the past decade. However, clear evidence of chaotic structures is usually prevented by large random components in the time series. In the first part of this paper we show that even if a sophisticated algorithm estimating and testing the positivity of the largest Lyapunov exponent is applied to time series generated by a stochastic dynamical system or a return series of a stock index, the results are difficult to interpret. We conclude that the notion of sensitive dependence on initial conditions as it has been developed for deterministic dynamics, can hardly be transfered into a stochastic context. Therefore, in the second part of the paper our starting point for measuring dependencies for stochastic dynamics is a distributional characterization of the dynamics, e.g. by heteroskedastic models for economic and financial time series. We adopt a sensitivity measure proposed in the literature which is an information-theoretic measure of the distance between probability density functions. This sensitivity measure is well defined for stochastic dynamics, and it can be calculated analytically for the classes of stochastic dynamics with conditional normal distributions of constant and state-dependent variance. In particular, heteroskedastic return series models such as ARCH and GARCH models are investigated. (author's abstract)

In _nancial econometrics the modelling of asset return series is closely related to the estimation of the corresponding conditional densities[ One reason why one is interested in the whole conditional density and not only in the conditional mean is that the conditional variance can be interpreted as a measure of time!dependent volatility of the return series[ In fact\ the mod! elling and the prediction of volatility is one of the central topics in asset pricing[ In this paper we propose to estimate conditional densities semi! non!parametrically in a neural network framework[ Our recurrent mixture density networks realize the basic ideas of prominent GARCH approaches but they are capable of modelling any continuous conditional density also allowing for time!dependent higher!order moments[ Our empirical analysis of daily FTSE 099 data demonstrates the importance of distributional assumptions in volatility prediction and shows that the out!of!sample fore! casting performance of neural networks slightly dominates those of GARCH models[ Copyright 1999 John Wiley + Sons\ Ltd[

We consider a dynamic game model in which N countries produce a single product that is not traded. Production results in emissions that accumulate a stock of pollution in each country. Households in each country derive utility from consuming the product but face costs depending on the level of the country-specific stock of pollution as well as the pollution stocks of the other countries. We distinguish three different cost scenarios. For all three, we show the existence of a Markov perfect equilibrium (MPE) and derive the collusive outcome. The MPEs are associated with the case where countries fail to coordinate their policies, while the collusive solutions correspond to the coordinated policy. JEL Classification No.: C73.

We formulate a class of dynamic games which consists of so‐called capital accumulationgames. In such games, rival firms invest strategically in a stock of physical capital. Thecapital stocks of all firms in the industry are the state variables of the game and firms usethe rate of change of the capital stocks as their control variables. It is assumed that currentprofits of a firm are not only dependent on the firm's own capital stock, but also on thestock of capital of the rival firm. We prove existence of multiple Markov Perfect Equilibria(MPE) and study their qualitative characteristics. It turns out that there exist two differenttypes of equilibria: a strict equilibrium that is degenerate and coincides with the uniqueopen‐loop one and so‐called indifferent equilibria that are non‐strict. For both types, westudy the equilibrium dynamics. While the strict equilibrium is characterized by simpleequilibrium dynamics, the indifferent equilibria may exhibit complex dynamic behaviour.

We consider a model in which two agents share access to the same stock of a productive asset and study the implications of non-cooperative consumption behavior over time. Under standard assumptions on the production function we construct infinitely many Nash equilibria, all of which consist of stationary Markovian strategies. These equilibria result in overconsumption so that the uniquely determined long-run asset stock is too low as compared to the cooperative solution. However, in the limit as the discount rate becomes sufficiently small the stead states generated by the Markovian Nash equilibria converge to the efficient steady state.Journal of Economic LiteratureClassification Numbers: C73, O41, Q22.

We analyze dynamic pricing strategies for new products over an infinite planning horizon in a duopolistic market. The sales dynamic is modelled as a linear demand function with saturation effects, marginal costs are assumed to be constant. The optimal pricing strategies are obtained as (degenerate) closed-loop Nash solutions. It is shown that the optimal dynamic prices are greater than the static ones. In the case of no discounting there is in addition to the constant solution also an equilibrium with monotonically increasing prices.

Credit risk has become an important factor driving government bond returns. We therefore introduce an asset pricing model which exploits information contained in both forward interest rates and forward CDS spreads. Our empirical analysis covers euro-zone countries with German government bonds as credit risk-free assets. We construct a market factor from the first three principal components of the German forward curve as well as a common and a country-specific credit factor from the principal components of the forward CDS curves. We find that predictability of risk premiums of sovereign euro-zone bonds improves substantially if the market factor is augmented by a common and an orthogonal country-specific credit factor. While the common credit factor is significant for most countries in the sample, the country-specific factor is significant mainly for peripheral euro-zone countries. Finally, we find that during the current crisis period, market and credit risk premiums of government bonds are negative over long subintervals, a finding that we attribute to the presence of financial repression in euro-zone countries.

This paper addresses positive aspects of the global warming debate that so far has been concerned by and large with normative issues. The paper considers a consumers' government that appreciates tax revenues as such (‘Leviathan’) in addition to conventional measures of welfare; i.e., carbon taxes serve the dual purpose of correcting for externalities — here global warming, or more generally, a stock externality from energy use — and of raising revenues. This government faces either a competitive or a perfectly cartelized supply. The major findings are: 1. (i) consumers may benefit from a Leviathan government that appropriates some of the monopoly rent by deterring preemption to some extent; 2. (ii) the Leviathan motive raises initial taxes and thereby lowers initial emissions but increases the long-run stock externality (in a play with linear strategies); 3. (iii) there exists a continuum of equilibria in nonlinear Markov strategies, which are, however, Pareto-inefficient compared with the linear strategies; 4. (iv) but in case of a binding resource constraint, nonlinear strategies are the only feasible ones.

In this paper, we consider a dynamic game model of two identical countries. Policy-makers of both countries have quadratic intertemporal objective functions and want to stabilize domestic output, domestic inflation, and the real rate of exchange. We present different analytical and numerical solutions for this policy game. Noncooperative open-loop equilibria are interpreted as requiring unilateral commitment and policy-makers' credibility. Potential gains from cooperation are present, as the noncooperative equilibrium solutions are not Pareto-optimal. Under an information pattern that admits memory strategies, the possibility of obtaining “cooperative” results without coordination and commitment arises.

We consider a differential game of R&D competition and explore the impact of rivalry on the firms' investment behavior over time. Using closed-loop strategies and hence allowing for strategic interactions among rival firms we show that R&D spending by the individual competitor is increased due to competition in the race for priority. This leads us to argue that competitive encounters enhance R&D activities at the same time as increasing efficiency in the race for a technological breakthrough.

We study the distinct impacts of own and rival actions on risk and return when firms strategically compete in the product market. Contrary to simple intuition, a competitor’s options to adjust capacity reduce own-firm risk. For example, if a rival possesses a growth option, an increase in industry demand directly enhances profits but also encourages value-reducing competitor expansion. The rival option thus acts as a natural hedge. Within the industry, we obtain endogenous differences in expected returns. In a leader-follower equilibrium, own-firm and competitor risks and required returns move together through contractions and oppositely during expansions, providing testable new predictions.

Accurate rating systems are of central importance for banks to price and manage their loan portfolios. A bank's choice to invest in a more accurate rating technology is based on a trade-off: the better rating system usually comes at higher cost, but endows the bank with a competitive advantage, which includes potentially better access to funds. This paper models the rating technology choice of a bank as a two-stage game in an oligopolistic banking sector. (author's abstract)

The separation of ownership and control in rms brings up the issue of how and what to delegate to managers. There exists a large body of literature that analyzes strategic delegation in which owners understand the incentives that managers face when they operate in imperfectly competitive product markets. In this paper we analyze strategic delegation under the assumption that rms operate in dynamic oligopolies. We derive the optimal strategic incentive in this setting and point out that the dynamic incentive can be replicated by a static one in which rms play a conjectural variations equilibrium in the output market.

A non-linear version of Parlar's production and marketing model is analysed. The optimal production and advertising policies are derived using the Maximum Principle. A stability analysis or the canonical system is carried out to determine the behaviour of production and marketing decisions over time. As the main result we show that the model might exhibit stable limit cycles as optimal policies. Using the Hopf Bifurcation Theorem the existence of a stable limit cycle is shown in a numerical example.

The purpose of this paper is to derive conditions for the optimality of a limit cycle in a dynamic economic system and to interpret them economically. A fairly general two-state continuous-time nonlinear optimal control problem is considered. It turns out that for this class of models three different economic mechanisms can be identified as the possible source of limit cycles. One relates to an intertemporal substitution effect expressed in terms of complementarity over time, the second one is a dominating cross effect between the state variables of the system (i.e., the capital stocks in our model), and the third one is positive growth at the equilibrium.

This book provides an insightful view of major issues in the economics of corporate governance (CG) and mergers. It presents a systematic update on the developments in the two fields during the last decade, as well as highlighting the neglected topics in CG research, such as the role of boards, CG and public interest and the relation of CG to mergers. Two important conclusions can be drawn from this book: the first is that corporate governance systems that better align shareholders’ and managers’ interests lead to better corporate performance; second, there is an important relationship between CG structures and the quality of firm decision-making, one of the most important being the decision to merge or take over another firm.

Problems of macroeconomic stabilization policies have been analyzed by means of optimal control theory since the early seventies [see, for example, Kendrick (1981)]. However, with the emergence of the New Classical Macroeconomics, this theoretical framework has been increasingly questioned. In particular, Kydland’s and Prescott’s (1977) claim that government’s stabilization policies derived by optimum control methods might be time-inconsistent when private-sector agents have rational expectations of policy-makers’ behaviour has been regarded as a serious argument against the use of optimum control theory in macroeconomics, although the real-world importance of time-inconsistent behaviour is still controversial. [For an early theoretical critique, see Hughes Hallett (1986a); for empirical analyses, Ireland (1999), Boschen and Weise (2004), among others.] Later research on time-inconsistency indicates that dynamic game theory is a more appropriate tool for analyzing stabilization policy problems because more than one decision-maker has to be considered explicitly. Therefore over the last three decades, a large number of studies of macroeconomic stabilization policies (as well as of other areas in economics) have made use of the concepts and results of the theory of dynamic games.