Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2014/26: When is it Better to Wait for a New Version? Optimal Replacement of an Emerging Technology under Uncertainty

Michail Chronopoulos () and Afzal Siddiqui ()
Additional contact information
Michail Chronopoulos: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Afzal Siddiqui: Department of Statistical Science, University College London, Postal: University College London , Department of Statistical Science, Gower Street, London, WC1E 6BT, UK

Abstract: We determine the optimal timing for replacement of an emerging technology facing uncertainty in both the output price and the arrival of new versions. Via a sequential investment framework, we determine the value of the investment opportunity, the value of the project, and the optimal investment rule under three different strategies: compulsive, laggard, and leapfrog. In the first one, we assume that a firm invests sequentially in every version that becomes available, whereas in the second and third ones, it can choose an older or a newer version, respectively. We show that, under a compulsive strategy, technological uncertainty has a non–monotonic impact on the optimal investment decision. In fact, uncertainty regarding the availability of future versions may actually hasten investment in the current one. Next, by comparing the relative values of the three strategies under different rates of technological innovation, we find that, under a low output price, the compulsive strategy always dominates, whereas, at a high output price, the incentive to wait for a new version and adopt either a leapfrog or a laggard strategy increases as the rate of innovation increases, while high price uncertainty mitigates this effect.

Keywords: Investment analysis; real options; emerging technologies

JEL-codes: G11; O33

32 pages, June 18, 2014

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