This chapter covers the basic mathematics needed to value the investment opportunities of firms that operate in an oligopolistic market. It combines the tools of (financial) option pricing and industrial organization. At a mathematical level the model presented here is a combination of optimal stopping theory and game theory. Most of the game theoretic real options literature is based on the notion of equilibrium introduced by Fudenberg and Tirole (1984, Review of Economic Studies). This chapter, however, builds on recent work by Thijssen (, mimeo), which exploits the strong Markovian nature of diffusions. The theory is applied to a simple duopoly where it is shown, numerically, that competition in a dynamic setting may be bad for welfare.
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