A cooperative stochastic differential game of knowledge technology development

Abstract

The development of knowledge-based capital constitutes a classic case of market failure which calls for cooperative optimization. However, cooperation cannot be sustainable unless there is guarantee that the agreed-upon optimality principle can be maintained throughout the planning duration. This paper derives subgame consistent cooperative solutions for the development of knowledge technology in a stochastic differential game framework. In particular, subgame consistency ensures that as the game proceeds firms are guided by the same optimality principle and hence they do not possess incentives to deviate from the previously adopted optimal behavior. A "payoff distribution procedure" leading to subgame consistent solutions is derived and a numerical example is presented. This is the first time that subgame consistent cooperative development of knowledge technology is analyzed.