Access pricing and investment: a real options approach

Camacho, Fernando T. and Menezes, Flavio M. (2009) Access pricing and investment: a real options approach. Journal of Regulatory Economics, 36 2: 107-126. doi:10.1007/s11149-009-9088-1

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Author Camacho, Fernando T.
Menezes, Flavio M.
Title Access pricing and investment: a real options approach
Journal name Journal of Regulatory Economics   Check publisher's open access policy
ISSN 0922-680X
Publication date 2009-02-11
Year available 2009
Sub-type Article (original research)
DOI 10.1007/s11149-009-9088-1
Volume 36
Issue 2
Start page 107
End page 126
Total pages 20
Editor Michael A. Crew
Place of publication Secaucus, NJ, United States
Publisher Springer
Collection year 2010
Language eng
Subject 140104 Microeconomic Theory
140209 Industry Economics and Industrial Organisation
Abstract This paper examines a three-period model of an investment decision in a network industry characterized by demand uncertainty, economies of scale and sunk costs. In the absence of regulation we identify the market conditions under which a monopolist decides to invest early as well as the overall welfare generated by this decision. In a regulated environment, we consider a vertically integrated network provider that is required to provide access to downstream competitors and compare two distinct access pricing methodologies: the Efficient Component Pricing Rule (ECPR) and the Option to Delay Pricing Rule (ODPR). We identify the welfare-maximizing access prices using the unregulated market output as a benchmark and show that optimal access regulation depends on market conditions (that is, the nature of demand) with two possible outcomes: (i) access prices that provide a positive payoff to the incumbent, that is, provide a positive compensation to account for the option to delay; and (ii) access prices that yield a zero payoff to the incumbent. Moreover, unlike the earlier literature that argues in favor of an ECPR-type methodology to account for the interaction between irreversibility and demand uncertainty, we find that, except under very specific conditions, an access price that accounts for the option to delay value is welfare-superior to the ECPR.
Keyword Real options
Option to delay
Regulation and investment
Access pricing
Q-Index Code C1
Q-Index Status Confirmed Code
Institutional Status UQ

Document type: Journal Article
Sub-type: Article (original research)
Collections: 2010 Higher Education Research Data Collection
School of Economics Publications
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Citation counts: TR Web of Science Citation Count  Cited 4 times in Thomson Reuters Web of Science Article | Citations
Scopus Citation Count Cited 6 times in Scopus Article | Citations
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Created: Fri, 04 Sep 2009, 10:26:29 EST