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Investment, uncertainty, and production games

Published online by Cambridge University Press:  01 February 2009

S. D. FLÅM  and
Y. M. ERMOLIEV
S. D. FLÅM
Affiliation:
Economics Department, Bergen University, Norway. Email: sjur.flaam@econ.uib.no
Y. M. ERMOLIEV
Affiliation:
IIASA, Luxenburg, Austria. Email: ermoliev@iiasa.ac.at
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Abstract

This paper explores a few cooperative aspects of investments in uncertain, real options. By hypothesis some production commitments, factors, or quotas are transferable. Cases in point include energy supply, emission of pollutants, and harvest of renewable resources. Of particular interest are technologies or projects that provide anti-correlated returns. Any such project stabilizes the aggregate proceeds. Therefore, given widespread risk aversion, a project of this sort merits a bonus. The setting is formalized as a two-stage, stochastic, production game. Absent economies of scale, such games are quite tractable in analysis, computation, and realization. A core imputation comes in terms of shadow prices that equilibrate competitive, endogenous markets. Such prices emerge as optimal dual solutions to coordinated production programs, featuring pooled commitments, or resources. Alternatively, the prices could result from repeated exchange.

Type
Research Article
Information
Environment and Development Economics , Volume 14 , Issue 1: GAME THEORY, NATURAL RESOURCES AND THE ENVIRONMENT , February 2009 , pp. 51 - 66
Copyright
Copyright © Cambridge University Press 2008

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