pricing under uncertainty : Margin squeezes , real options , and the cost of capital ?

Recent studies have emphasized the role of irreversibility, flexibility, and uncertainty in assessing the financial implications of regulated access pricing in the telecommunications market (Pindyck 2004, 2005). In particular it has been argued that mandatory unbundling of the local loop creates optionalities (real options), leading to a transfer of wealth from incumbents to entrants unaccounted for by a static investment perspective. We extend this line of research by explicitly considering the significance of margin squeezes, predatory pricing, and related pricing rules in a duopoly model tailored to the German context. Analytical and numerical methods are employed to characterize pricing behavior and market dynamics under demand uncertainty. We draw conclusions with respect to the incumbent’s cost of capital under regulatory intervention.