Sharing R&D Risk in Healthcare via FDA Hedges

Adam Jørring, Andrew Lo (), Tomas Philipson, Manita Singh and Richard Thakor

No 23344, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The high cost of capital for firms conducting medical research and development (R&D) has been partly attributed to the government risk facing investors in medical innovation. This risk slows down medical innovation because investors must be compensated for it. We analyze new and simple financial instruments, Food and Drug Administration (FDA) hedges, to allow medical R&D investors to better share the pipeline risk associated with FDA approval with broader capital markets. Using historical FDA approval data, we discuss the pricing of FDA hedges and mechanisms under which they can be traded and estimate issuer returns from offering them. Using various unique data sources, we find that FDA approval risk has a low correlation across drug classes as well as with other assets and the overall market. We argue that this zero-beta property of scientific FDA risk could be a main source of gains from trade between issuers of FDA hedges looking for diversified investments and developers looking to offload the FDA approval risk. We offer proof of concept of the feasibility of trading this type of pipeline risk by examining related securities issued around mergers and acquisitions activity in the drug industry. Overall, our argument is that, by allowing better risk sharing between those investing in medical innovation and capital markets more generally, FDA hedges could ultimately spur medical innovation and improve the health of patients.

JEL-codes: G11 G12 G13 G22 G23 G31 I18 K23 L65 O32 (search for similar items in EconPapers)
Date: 2017-04
New Economics Papers: this item is included in nep-hea and nep-ino
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Citations: View citations in EconPapers (7)

Published as Adam Jørring & Andrew W Lo & Tomas J Philipson & Manita Singh & Richard T Thakor & Andrew Ellul, 2022. "Sharing R&D Risk in Healthcare via FDA Hedges," The Review of Corporate Finance Studies, vol 11(4), pages 880-922.

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