7. Conclusion
In this study, we introduce a Markov switching regime as Driffill et al. (2013) into the model of Pawlina and Kort (2006) to consider the investment problem of asymmetric firms with regime uncertainty. In the case of no regime switch, a profitable firm always becomes the leader in the investment, and a disadvantaged firm never has an incentive to become the leader in a newly developing market. However, if there is uncertainty in the regime, there are some parameter settings in which both firms can be the leader even when the initial state variable is at a lower level. This finding shows a stark contrast to Pawlina and Kort (2006) as our model can provide richer results within a unified framework. From the numerical calculations, we conclude that regime uncertainty can have a big impact on the investment decision and the market equilibrium. When there is a regime switching structure in the economy, each firm needs to take the probability and effect of a regime change into account, which can cause a shift of the equilibrium type. In addition, the equity risk premium tends to be higher when the expected growth rate is low. This theoretical result describes previous empirical findings in a more precise way than other extant studies. For future study, it is important to consider the changes of profitability and cost invoked by the regime. It is natural that the firm’s profitability and cost are better in a boom than in a bust. By doing this, we will be able to explain more complicated economic behavior of firms facing the entry race under uncertainty.
