Investment, Uncertainty, and Cooperation

Flam, S.D. & Ermoliev, Y.M. (2004). Investment, Uncertainty, and Cooperation. IIASA Interim Report. IIASA, Laxenburg, Austria: IR-04-012

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Abstract

This paper explores some cooperative aspects of investments in uncertain, real options. Key production factors are assumed transferable. They may reflect property or user rights. Emission of pollutants and harvest of renewable resources are cases in point. Of particular interest are alternative projects or technologies that provide inferior but anti-correlated returns. Any such project stabilizes the aggregate proceeds. Therefore, given widespread risk exposure and aversion, that project's worth may embody an extra bonus.

The setting is formalized as a stochastic production game. Granted no economies of scale of such games are quite tractable in analysis, computation, and realization. A core imputation comes in terms of contingent shadow prices that equilibrate competitive, endogenous markets. The said prices emerge as optimal dual solutions to coordinated production programs, featuring pooled resources - and also via adaptive procedures. Extra value - or an insurance premium - adds to any project whose yield is negatively associated with the aggregate.

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