A study of product and financial market interactions

This dissertation investigates the interaction between product and financial markets. In the first part of the thesis, we study a potential entrants entry and output decisions given the existence of a market of options on the stock of incumbent firms. We model this by incorporating an options market in an entry game where the output market is characterized by Cournot competition. We first consider the case where the incumbent is a monopolist. The entrant is assumed to have private information about its entry decision. Since the entrant has knowledge of the post-entry value of the incumbent which we expect to be lower than the pre-entry value, it provides an opportunity for the entrant to profit from the options market by purchasing put options on the stock of the incumbent. The purchase of put options on the stock of the incumbent provides another source of profit for the entrant besides the profit for the product market. The model is then extended to N incumbents. The second part of the thesis is an empirical study of the stock price returns of competitors when a rival firm introduces a new product in the computer industry. It is found that in some sectors of the computer industry, competitors experience significant negative abnormal returns when a substitute good is introduced, providing support for the basic assumption of the model