A Model for Evaluating Pharmaceutical R&D Investment Projects under Technical and Economic Uncertainties

Enrico Pennings and Luigi Sereno

ERIM Report Series Research in Management from Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam

Abstract: This study sets up a compound option approach for evaluating pharmaceutical R&D investment projects in the presence of technical and economic uncertainties. Technical uncertainty is modeled as a Poisson jump that allows for failure and thus abandonment of the drug development. Economic uncertainty is modeled as a standard di¤usion process which incorporates both up-and downward shocks. Practical application of this method is emphasized through a case analysis. We show that both uncertainties have a positive impact on the R&D option value. Moreover, from the sensitivity analysis, we nd that the sensitivity of the option with respect to economic uncertainty and market introduction cost decreases when technical uncertainty increases.

Keywords: G13; G24; G30; R&D; compound option; jump-discussion process; pharmaceutical industry (search for similar items in EconPapers)
JEL-codes: C6 D21 L20 M O32 (search for similar items in EconPapers)
Date: 2010-02-18
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Citations: View citations in EconPapers (2)

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