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Patents and R&D as Real Options

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Author Info
Eduardo S. Schwartz
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. Copyright Banca Monte dei Paschi di Siena SpA, 2004

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Article provided by Banca Monte dei Paschi di Siena SpA in its journal Economic Notes.

Volume (Year): 33 (2004)
Issue (Month): 1 (02)
Pages: 23-54
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Handle: RePEc:bla:ecnote:v:33:y:2004:i:1:p:23-54

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  1. Philipp N. Baecker, 2006. "An Option-Based View of Imperfect Patent Protection," ebs Working Papers on Finance and Accounting 060601, Department of Finance and Accounting, EUROPEAN BUSINESS SCHOOL (ebs), International University Schloß Reichartshausen, revised 10 Jan 2007. [Downloadable!]
  2. Joseph Golec, 2007. "Commentary," Health Economics, John Wiley & Sons, Ltd., vol. 28(4-5), pages 353-355. [Downloadable!]
  3. Angel Leon & Diego Piñeiro, 2004. "Valuation Of A Biotech Company: A Real Options Approach," Working Papers wp2004_0420, CEMFI. [Downloadable!]
  4. Joseph Golec, 2007. "Commentary," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(4-5), pages 353-355. [Downloadable!]
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