Stackelberg Leadership in a Dynamic Duopoly with Stochastic Capital Accumulation

I propose a dynamic duopoly model where firms enter simultaneously but compete hierarchically à la Stackelberg at each instant over time. They accumulate capacity through costly investment, with capital acumulation dynamics being affected by an additive shock the mean and variance of which are known. The main findings are the following. First, the Stackelberg game is uncontrollable by the leader; hence, it is time consistent. Second, the leader invests more than the follower; as a result, in the steady state, the leader's capacity and profits are larger than the follower's. Therefore, the present analysis does not confirm Gibrat's Law, since the individual growth rate is determined by the timing of moves. JEL Classification: C61, C73, D43, D92, L13 Keywords: differential games, time consistency, investment, optimal control methods, Stackelberg equilibrium