Real Options: Institutional Implications for Vertical Inte- Gration of Production Chains in Competitive Environments

Participants along a production chain which exchange intermediate products on spot markets face price risks, such as the transmission of price fluctuations of the final product. In a real options environment this uncertainty may cause investment reluctance on the different steps of the production chain. This paper analyzes weather a stronger vertical integration along the production chain allows to reduce the investment reluctance. Therefore, an agent-based competitive model of the pork production chain is developed in which farmers use optimal investment strategies which are identified by genetic algorithms. Two production systems are compared: As example for a perfectly integrated system it is considered that every farmer can invest in closed systems in which piglets (the intermediate product) and finished hogs (the final product) are produced in equal amounts. In an alternative production system, farmers can either invest in farrowing (i.e. the production of piglets) or in hog finishing. The intermediate product, i.e. piglets, is traded on a spot market. Simulations show that the spot market solution and the closed system lead to the same production dynamics. The only precondition is that in the spot market system farrowers and hog finishers are aware of the investment strategies, respectively the production capacities of the market partners. This general finding is even independent of different depreciation rates on the production steps, though the price dynamics changes.