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Incorporating technical risk in compound real option models to value a pharmaceutical R&D licensing opportunity

Danny Cassimon (), M. De Backer, Peter-Jan Engelen, Martine van Wouwe () and V. Yordanov

Research Policy, 2011, vol. 40, issue 9, 1200-1216

Abstract: The valuation of multi-staged pharmaceutical R&D can be interpreted as a chain of real options. In valuing these compound option models, a crucial problem is how to deal with the different types of risk. Previous models, such as Cassimon et al. (2004), offer a closed-form solution for the valuation of a new drug development using a generalized n-fold compound option model, but implicitly bundle both commercial and technical risk in one risk measure. We extend this model by explicitly incorporating technical risk, while still preserving the closed-form solution of the model. As such, this extended model is better suited to handle real-life valuation cases in the pharmaceutical industry. We document the theoretical model with a real-life project of a major pharmaceutical multinational.

Keywords: Pharmaceutical R&D; Real options; Compound option model; Technical risk; Case study (search for similar items in EconPapers)
JEL-codes: C6 G12 G24 G31 (search for similar items in EconPapers)
Date: 2011
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