A Real Options Perspective on R&D Portfolio Diversification

Sjoerd van Bekkum, Enrico Pennings and Han Smit
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Sjoerd van Bekkum: Erasmus University Rotterdam
Han Smit: Erasmus University Rotterdam, the Netherlands

No 08-003/2, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This paper shows that the presence of conditional staging in R&D (Research & Development) has a critical impact on portfolio risk, and changes diversification arguments when a portfolio is constructed. When R&D projects exhibit option-like characteristics, correlation between projects plays a more complicated role than traditional portfolio diversification would suggest. Real option theory argues that research projects with conditional phases have option-like risk and return properties, and are different from unconditional projects. We show that although the risk of a portfolio always depends on the correlation between projects, a portfolio of conditional R&D projects with real option characteristics has fundamentally different risk than a portfolio of unconditional projects. When conditional R&D projects are negatively correlated, portfolio risk is hardly reduced by diversification. When projects are positively correlated, however, diversification is more effective than these tools predict.

This discussion paper resulted in an article in Research Policy (2009). Volume 38, pages 1150-1158.

Keywords: Real Options; Research & Development (R&D); Risk Management; Monte Carlo Simulation (search for similar items in EconPapers)
JEL-codes: G31 G32 O30 O32 (search for similar items in EconPapers)
Date: 2007-01-15, Revised 2009-05-15
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Related works:
Journal Article: A real options perspective on R&D portfolio diversification (2009)
Working Paper: A Real Options Perspective On R&D Portfolio Diversification (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20080003

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