A Real Options Approach to Watchful Waiting: Theory and an Illustration

Tarn Driffield and Peter C. Smith
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Tarn Driffield: Centre for Health Economics, University of York
Peter C. Smith: Centre for Health Economics, University of York, pcs1@york.ac.uk

Medical Decision Making, 2007, vol. 27, issue 2, 178-188

Abstract: Watchful waiting is a form of clinical management under which immediate curative treatment is not given. Instead, the patient undergoes a period of observation during which periodic tests monitor the progression of the illness. Hitherto, little attention has been given to how such patient management should be modeled from an economic perspective. Watchful waiting preserves an “option†to start treatment some time in the future, and evaluating a watchful waiting regime therefore has close analogies with pricing a financial option in the derivatives market. This article demonstrates how the methods used to price financial options can be used to decide when to pursue a watchful waiting strategy for a particular patient. The principles of option pricing are illustrated with the example of abdominal aortic aneurysm. A simple trinomial model of disease progression is used, in which patients are periodically monitored, and their health state can remain unchanged, deteriorate, or improve. Backward induction is used to solve the model at each period, with optimal treatment recommendations depending on the current health state. At very low levels of expected net benefits, the patient is discharged. At high levels, the patient is treated immediately. At intermediate levels, watchful waiting continues. The authors argue that option pricing methods offer important insights into the evaluation of a watchful waiting strategy. The methods also have potential applications in other domains of medical care. Key words: watchful waiting; option pricing; cost-effectiveness analysis. (Med Decis Making 2007;27:178—188)

Date: 2007
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Persistent link: https://EconPapers.repec.org/RePEc:sae:medema:v:27:y:2007:i:2:p:178-188

DOI: 10.1177/0272989X06297390

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