Patents and R&D as Real Options

Eduardo S. Schwartz

No 10114, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This article develops and implements a simulation approach to value patents and patent-protected R&D projects based on the Real Options approach. It takes into account uncertainty in the cost-to-completion of the project, uncertainty in the cash flows to be generated from the project, and the possibility of catastrophic events that could put an end to the effort before it is completed. It also allows for the possibility of abandoning the project when costs turn out to be larger than expected or when estimated cash flows turn out to be smaller than anticipated. This abandonment option represents a very substantial part of the project's value when the project is marginal or/and when uncertainty is large. The model presented can be used to evaluate the effects of regulation on the cost of innovation and the amount on innovative output. The main focus of the article is the pharmaceutical industry. The framework, however, applies just as well to other research-intensive industries such as software or hardware development.

JEL-codes: G31 O22 (search for similar items in EconPapers)
Date: 2003-11
New Economics Papers: this item is included in nep-cfn and nep-tid
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Citations: View citations in EconPapers (11)

Published as Schwartz, Eduardo S. “Patents and R&D as Real Options.” Economic Notes 33, 1 (2004): 23-54.

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