Company valuation under interaction in discrete time (real game options model)

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JEL classification

• Game Theory and Bargaining Theory: General
• Value Theory
• Contingent Pricing; Futures Pricing; option pricing

Keywords

Game theory, real game option, real option, valuation

Abstract

Company valuation is a crucial topic in financial decision making. The advanced valuation method is the real options approach realised under risk and flexibility. It reflects a stochastic feature of the underlying asset and dynamic managerial decision making. Another aspect of valuation, which is often neglected, is interaction, meaning the mutual impact of other companies on the calculated value. Game theory models this aspect. The paper’s objective is to describe and apply company two-phase real game options valuation in discrete time. A generalised real game options valuation model based on the two-phase method, discrete time, risk-neutral proba-bility, and switching cost is formulated. The game categorisation is introduced, especially market structure games, including equilibrium calculations following pure and mixed strategies, and the real game options model is formu-lated. A company two-phase valuation method in the Cournot production duopoly market structure under random demand is developed, and an illustrative example is presented. The paper confirms the possibility of modelling company two-phase value through real game options valuation models. Neglecting an interaction under a non-perfect market structure can undervalue a company, so this aspect is essential.