Investment in Next Generation Networks and the Role of Regulation: A Real Option Approach

The parameters used for Citéfibre reflect the assumption that the new entrant operates
in absence of any regulation. By calibrating the model with the parameters of the new
entrant operator (see Table 3), we obtain a fugit variable equal to 0 (highlighted cell). The
model correctly predicts that the optimal policy for Citéfibre in the second half of 2005 was
to undertake the investment (which it did).

The volatility of returns on the investment carried out by the Parisian FttH operator is
such that any reduction of cash flows during the “volatile phase” (top row; left column) or
of cash flows in the “steady phase” (middle row; left column) tilts the decision to invest.
Thus, all regulatory interventions on the new entrant would prevent it from investing. The
outcome and a sensitivity analysis for a new entrant operator are presented in Table 3.

The sensitivity analysis concerns the up-front cost of the investment (strike price),
which is allowed to vary by ±12% with respect to the base value; the payout rate, whose
interval is assumed to lie in between ±0.5 around the central value of 1.2%; the volatility,
which we allow to be lower than the reported value of 0.78, if the stock were more liquid;
the NPV (asset price) of the project which can vary by ±20%. In most cases, the optimal
time to invest remains “now”. As expected, the investment tends to be deferred (up to
almost four years) when the investment cost rises or its payout falls; on the other hand, as
the NPV decreases, the project is delayed because the probability of not recovering the
upfront costs increases.

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