Valuation of R&D compound option using Markov chain approach

Guglielmo D’Amico () and Giovanni Villani ()
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Guglielmo D’Amico: University of Chieti-Pescara
Giovanni Villani: University of Bari

Annals of Finance, 2021, vol. 17, issue 3, No 4, 379-404

Abstract: Abstract Incorporation of technical risk in compound real options has been considered in Cassimon et al. (2011) concerning the valuation of multi-stage pharmaceutical R&D. There, the technical success probabilities at each development stage were assumed to be generated independently of each other. This assumption can be unrealistic in many applied problems, pharmaceutical R&D included. We present a valuation procedure dealing with dependent success probabilities and random development stage times. This greater flexibility allows a better description of the sequence of decision stages and results, which in turn, impact the value of the considered project. The theoretical results are illustrated through a numerical example that shows the implementation of the model to a pharmaceutical R&D problem.

Keywords: Real option; Technical risk; Compound option; C02; G11 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (3)

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DOI: 10.1007/s10436-021-00389-1

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