Impact of Bayesian Learning and Externalities on Strategic Investment

Management Science 62(2) 550–570 (2016)

38 Pages Posted: 9 Jan 2015 Last revised: 9 Jan 2019

See all articles by H. Dharma Kwon

H. Dharma Kwon

University of Illinois at Urbana-Champaign - Gies College of Business

Wenxin Xu

University of Illinois at Urbana-Champaign - Department of Business Administration

Anupam Agrawal

Texas A&M University

Suresh Muthulingam

The Pennsylvania State University, Smeal College of Business

Date Written: January 5, 2015

Abstract

We investigate the interplay between learning effects and externalities in the problem of competitive investments with uncertain returns. We examine a game theoretic duopoly investment model in which (i) a firm can learn about the profitability of the investment by observing the performance of the first mover and (ii) externalities exist between the investments of two firms. We find a region of a war of attrition between the two firms in which the interplay between externalities and learning gives rise to counterintuitive effects on investment strategies and payoffs. In particular, we find that, contrary to the conventional war of attrition where an increase in benefits for the follower generally delays the first move, an increase in the rate of learning -- which tends to benefit the follower -- can hasten the first investment.

Keywords: Strategic investment, externalities, Bayesian learning, Games/group decisions, stochastic, decision analysis, sequential, dynamic programming/optimal control

Suggested Citation

Kwon, H. Dharma and Xu, Wenxin and Agrawal, Anupam and Muthulingam, Suresh, Impact of Bayesian Learning and Externalities on Strategic Investment (January 5, 2015). Management Science 62(2) 550–570 (2016), Available at SSRN: https://ssrn.com/abstract=2546418

H. Dharma Kwon (Contact Author)

University of Illinois at Urbana-Champaign - Gies College of Business ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Wenxin Xu

University of Illinois at Urbana-Champaign - Department of Business Administration ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Anupam Agrawal

Texas A&M University ( email )

Langford Building A
798 Ross St.
College Station, TX 77843-3137
United States

Suresh Muthulingam

The Pennsylvania State University, Smeal College of Business ( email )

University Park, PA 16802
United States

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