Incorporating option values into the economic evaluation of health care technologies

Stephen Palmer () and Peter Smith ()
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Stephen Palmer: Centre for Health Economics, The University of York
Peter Smith: Centre for Health Economics, The University of York

No 166chedp, Working Papers from Centre for Health Economics, University of York

Abstract: Despite uncertainty being intrinsic to economic evaluation of health care, existing techniques for handling uncertainty remain underdeveloped compared to the formal techniques commonly applied in the business sector. This paper develops an alternative approach to handling uncertainty in economic evaluation based on the quantification of uncertainty using ‘option pricing’ techniques. The central feature of option pricing is that investments are rarely ‘now or never’ propositions. The presence of uncertainty and the degree of irreversibility of a decision makes it clear that some flexibility in the timing of a decision is often a desirable characteristic with an economic value. We demonstrate how, with modification, option pricing techniques can be applied to the decision rules for economic evaluation, illustrating how the presence of even modest degrees of uncertainty can give rise to substantial changes in the investment criterion for economic evaluation. The paper concludes by identifying the key determinants of the ‘option value’, namely the presence and type of uncertainty; the ability to defer a decision; and the irreversibility of the decision. The relative significance of each of these key determinants on the decision rules for economic evaluation will depend on the particular characteristics of the technology under consideration.

Pages: 27 pages
Date: 1999-03
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chy:respap:166chedp

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