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Optimal R&D investment for a risk-averse entrepreneur

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  • Whalley, A. Elizabeth
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    Abstract

    Entrepreneurs investing in R&D projects face technical uncertainty associated with the cost to completion of the project, which is idiosyncratic and inherently unhedgeable. We extend existing real options models of R&D investment to incorporate the cost of bearing this unhedgeable risk and find it decreases risk-averse entrepreneurs' valuations of R&D projects and increases the minimum NPVs required for continued investment in R&D (threshold NPVs) relative to 'unpriced risk' values and threshold NPVs. As in the 'unpriced risk' case, for less risk-averse entrepreneurs with small R&D projects, threshold NPVs remain negative and decrease with technical uncertainty. However, for sufficiently risk-averse entrepreneurs with sufficiently large R&D projects, threshold NPVs can become positive and increase with technical uncertainty.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

    Volume (Year): 35 (2011)
    Issue (Month): 4 (April)
    Pages: 413-429

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    Handle: RePEc:eee:dyncon:v:35:y:2011:i:4:p:413-429

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    Web page: http://www.elsevier.com/locate/jedc

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    Keywords: R&D Technical uncertainty Entrepreneurial investment Cost of unhedgeable risk Utility maximisation;

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