Optimal R&D investment for a risk-averse entrepreneur

A. Elizabeth Whalley

Journal of Economic Dynamics and Control, 2011, vol. 35, issue 4, 413-429

Abstract: Entrepreneurs investing in R&D projects face technical uncertainty associated with the cost to completion of the project, which is idiosyncratic and inherently unhedgeable. We extend existing real options models of R&D investment to incorporate the cost of bearing this unhedgeable risk and find it decreases risk-averse entrepreneurs' valuations of R&D projects and increases the minimum NPVs required for continued investment in R&D (threshold NPVs) relative to 'unpriced risk' values and threshold NPVs. As in the 'unpriced risk' case, for less risk-averse entrepreneurs with small R&D projects, threshold NPVs remain negative and decrease with technical uncertainty. However, for sufficiently risk-averse entrepreneurs with sufficiently large R&D projects, threshold NPVs can become positive and increase with technical uncertainty.

Keywords: R&D; Technical; uncertainty; Entrepreneurial; investment; Cost; of; unhedgeable; risk; Utility; maximisation (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:35:y:2011:i:4:p:413-429

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