July 3, 2012

Optimal regulation of lumpy investments

We study optimal timing of regulated investment in a real options setting, in which the regulated monopolist has private information on investment costs. In solving the ensuing agency problem, the regulator trades off investment timing inefficiency against the dead-weight loss arising from high price caps.
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We show that optimal regulation is implemented by a price cap that decreases as a function of the monopolist's chosen investment time.








Gijsbert Zwart
Peter Broer