Option Exercise Games in Spatial Economies

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This study consists of two parts. The first part develops a theory that explains strategic behavior of oligopoly firms under dynamic uncertainty (ie. "option game theory"). Specifically, we consider dynamic equilibrium strategies of oligopoly firms producing a single commodity with random demand fluctuation, assuming that each firm can change its strategic variables (such as output price level) at any time. We find a dependence relation of the equilibrium strategies and stochastic state variables, and show that the result dramatically changes depending on whether commodity demands are complementary or substitute. Furthermore, we reveal the clear relation between the equilibrium state and a socially optimum state. The second part studies several option games in a spatial economy. Specifically, we consider a location equilibrium between a landlord and a firm with entry and exit options under the profit risk due to stochastic economic factors. The study reveals several properties of the dynamic equilibrium : 1)the landlord's equilibrium strategy is to permit the firm's entry (locate at the land) immediately when the volatility of the economic factor is sufficiently low, 2)in the equilibrium under the firm's free exit rule, the landlord raises the rent as the volatility increases to cover the decrease in his expected revenue due to the increase in the risk of firm's exit, 3)banning the firm from exiting improves not only the welfare of landlord but also that of firms (ie. Pareto improvement) because, under the banning rule, the landlord can decrease the rent level, which makes the firm better off than the firm having an exit option paying a higher equilibrium rent.