Next Generation Networks and Cost-Based Bitstream Access : Pricing Asymmteric Flexibility Using Contingent Claim Analysis

Questions about the efficacy of cost-based prices, as a basis for pricing capacity access in telecommunication networks, continue to dominate the debate in both theory and practice. The literature questions the versatility of cost-based access from the standpoint of option pricing theory. The question at the core of this debate is the shortcoming of cost based prices in the face of the asymmetric distribution of downstream risk. This debate currently resonates strongly with the transition to Next Generation Networks, given the considerable investment and risk that this transition entails. While the literature mainly provides qualitative conjectures about the potential shortcomings of cost-based price regulation, it still lacks a rigorous treatment of the asymmetry alluded to. Therefore the basis to quantify the relative value of the asymmetry remains unresolved. We use contingent claim analysis to provide a rigorous treatment of how the risk associated third-party bitstream access can be priced in Next Generation Access (NGA) platforms, based on European evidence. We employ a two-dimensional model to capture the stochastic dynamics of downstream value to virtual providers. The model captures the value arising from the flexibility of favorably timing entry and exit decisions to the drivers of downstream value. Based on the overall mechanics of open access, which give virtual providers the right but not the obligation to participate in the downstream market - the value that accrues to such providers is, in effect, a bundle of contingent claims. These claims are valued using contingent claim analysis where Q-values are determined via the market price of risk. Finally, this paper provides a closed-form solution for valuing the asymmetrical distribution of risk associated with bitstream access in NGNs