Valuation of sequential R&D investment under technological, market, and rival preemption uncertainty

Michi Nishihara ()
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Michi Nishihara: Graduate School of Economics, Osaka University

No 14-13, Discussion Papers in Economics and Business from Osaka University, Graduate School of Economics

Abstract: We develop a real options model for evaluating and optimizing an R&D project. The model can capture key features of R&D, including research duration, growth opportunity, debt financing, and uncertainty of technological, demand market, and rival preemption. Nevertheless, it is computationally tractable and thus helps practitioners to evaluate various cases of R&D investment. Further, by analyzing the model with a wide range of parameter values, we unveil the interactions of key R&D features. The effect of duration on investment depends on whether there is a possibility of rival preemption. Higher uncertainty of research duration speeds up project inception in the presence of rival preemption. Higher uncertainty of technological success, combined with a growth opportunity embedded in the R&D project, accelerates investment. Debt financing can greatly decrease time lag between the first stage project and growth project. These results are consistent with the empirical evidence.

Keywords: R&D; technological uncertainty; investment lag; real options; compound option. (search for similar items in EconPapers)
JEL-codes: G31 G33 O32 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2014-04
New Economics Papers: this item is included in nep-ger, nep-gro, nep-ino and nep-ppm
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Persistent link: https://EconPapers.repec.org/RePEc:osk:wpaper:1413

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