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A Real Options Perspective On R&D Portfolio Diversification

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Author Info
Bekkum, S. van
Pennings, H.P.G.
Smit, J.T.J. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)

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Abstract

This paper shows that the conditionality of investment decisions in R&D has a critical impact on portfolio risk, and implies that traditional diversification strategies should be reevaluated when a portfolio is constructed. Real option theory argues that research projects have conditional or option-like risk and return properties, and are different from unconditional projects. Although the risk of a portfolio always depends on the correlation between projects, a portfolio of conditional R&D projects with real option characteristics has a fundamentally different risk than a portfolio of unconditional projects. When conditional R&D projects are negatively correlated, diversification only slightly reduces portfolio risk. When projects are positively correlated, however, diversification proves more effective than conventional tools predict.

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File URL: http://hdl.handle.net/1765/15410
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Publisher Info
Paper provided by Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam. in its series Research Paper with number ERS-2009-019-STR Revision_Date: 2009-07-29.

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Date of creation: 03 Apr 2009
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Handle: RePEc:dgr:eureri:1765015410

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Related research
Keywords: real options; portfolio analysis; research & development;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  1. Cassimon, D. & Engelen, P. J. & Thomassen, L. & Van Wouwe, M., 2004. "The valuation of a NDA using a 6-fold compound option," Research Policy, Elsevier, vol. 33(1), pages 41-51, January. [Downloadable!] (restricted)
  2. Rainer Brosch, 2001. "Portfolio-aspects in real options management," Working Paper Series: Finance and Accounting 66, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
  3. James L. Smith & Rex Thompson, 2005. "Diversification and the Value of Exploration Portfolios," Working Papers 0507, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research. [Downloadable!]
  4. Thomke, Stefan H., 1997. "The role of flexibility in the development of new products: An empirical study," Research Policy, Elsevier, vol. 26(1), pages 105-119, March. [Downloadable!] (restricted)
  5. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November. [Downloadable!] (restricted)
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