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Production of a New Drug: A Sequential Investment ProcessUnder Uncertainty

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  • Marcello Basili

    ()

  • Roberto Renò

    ()

  • Carlo Zappia

    ()

Abstract

On the basis of a database of more than 80 thousand records on total retails and production costs of the pharmaceutical industry worldwide we consider four classes of drugs. We evaluate the expected profits of an investment in a new drug in the four classes of pharmaceutical products by considering the standard NPV evaluation. We compare these outcomes with the evaluation of the expected profits of the four new drugs obtained by the real option approach. Interestingly enough quite different outcomes are obtained. These results loom on the capacity of standard methods to give a reliable evaluation of real investment projects that are analogous to compound options

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Bibliographic Info

Paper provided by Department of Economics, University of Siena in its series Department of Economics University of Siena with number 453.

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Date of creation: Jul 2005
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Handle: RePEc:usi:wpaper:453

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Keywords: compound option; real option valuation; net present value; drugs;

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  1. DiMasi, Joseph A. & Hansen, Ronald W. & Grabowski, Henry G. & Lasagna, Louis, 1991. "Cost of innovation in the pharmaceutical industry," Journal of Health Economics, Elsevier, vol. 10(2), pages 107-142, July.
  2. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  3. Gene M. Grossman & Carl Shapiro, 1986. "Optimal Dynamic R&D Programs," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 581-593, Winter.
  4. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
  5. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
  6. Robert S. Pindyck, 1992. "Investments of Uncertain Cost," NBER Working Papers 4175, National Bureau of Economic Research, Inc.
  7. DiMasi, Joseph A. & Hansen, Ronald W. & Grabowski, Henry G., 2003. "The price of innovation: new estimates of drug development costs," Journal of Health Economics, Elsevier, vol. 22(2), pages 151-185, March.
  8. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
  9. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
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