Is the myopic investor right? Numerical evidence for systematic overestimation of investment reluctance for real options

Empirical applications of real options models in competitive environments implicitly exploit the optimality of myopic planning. In a seminal paper Leahy (1993) shows that the optimal investment strategy of a myopic planner, who ignores market entries and exits of competitors as well as the resulting price effects, also constitutes a market equilibrium under rather general conditions. As a result, the calculation of optimal investment strategies is simplified considerably because competition does not have to be taken into account. In this paper, however, we demonstrate that myopic planning may lead to non-optimal investment strategies. This is due to the fact that it is difficult, or even impossible, to specify the correct or equivalent price process for the myopic investor using real world data. The myopic investor acts on the assumption of an unregulated (exogenous) price process. But what we observe in the real (competitive) world is indeed the outcome of a regulated (endogenous) price process. Hence, an estimation of parameters which is based on the unregulated form of stochastic process is inconsistent. This misconception, whose outcome we call “competitive bias”, has been widely ignored in the literature. Our paper quantifies this bias, analyses its determinants and shows the outcome of alternative estimation procedures which could be used to get around it. It turns out that due to the “competitive bias” the widely acknowledged “reluctance to invest” is overestimated. The suitability of alternative estimation methods depends on their respective specifications.