A Real Options Perspective on R&D Portfolio Diversification
AbstractThis paper shows that the presence of conditional staging in R&D (Research & Development) has a critical impact on portfolio risk, and changes diversification arguments when a portfolio is constructed. When R&D projects exhibit option-like characteristics, correlation between projects plays a more complicated role than traditional portfolio diversification would suggest. Real option theory argues that research projects with conditional phases have option-like risk and return properties, and are different from unconditional projects. We show that 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 fundamentally different risk than a portfolio of unconditional projects. When conditional R&D projects are negatively correlated, portfolio risk is hardly reduced by diversification. When projects are positively correlated, however, diversification is more effective than these tools predict.
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 08-003/2.
Date of creation: 15 Jan 2007
Date of revision: 15 May 2009
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Web page: http://www.tinbergen.nl
Real Options; Research & Development (R&D); Risk Management; Monte Carlo Simulation;
Other versions of this item:
- van Bekkum, Sjoerd & Pennings, Enrico & Smit, Han, 2009. "A real options perspective on R&D portfolio diversification," Research Policy, Elsevier, vol. 38(7), pages 1150-1158, September.
- Bekkum, S. van & Pennings, H.P.G. & Smit, J.T.J., 2009. "A Real Options Perspective On R&D Portfolio Diversification," Research Paper 1765015410, 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 Uni.
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- O30 - Economic Development, Technological Change, and Growth - - Technological Change; Research and Development; Intellectual Property Rights - - - General
- O32 - Economic Development, Technological Change, and Growth - - Technological Change; Research and Development; Intellectual Property Rights - - - Management of Technological Innovation and R&D
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-02-23 (All new papers)
- NEP-CFN-2008-02-23 (Corporate Finance)
- NEP-INO-2008-02-23 (Innovation)
- NEP-IPR-2008-02-23 (Intellectual Property Rights)
- NEP-PPM-2008-02-23 (Project, Program & Portfolio Management)
- NEP-RMG-2008-02-23 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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- Pennings, H.P.G., 2010. "Does Contract Complexity Limit Opportunities? Vertical Organization and Flexibility," Inaugural Address EIA-2010-044-STR, 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 Uni.
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