A new real option methodology for the quality-by-design pharmaceutical research and development

We propose a novel compound real option quality-by-design decision methodology for multistage pharmaceutical R&D grounded in Lévy processes modelling. Our approach addresses the pressing R&D valuation and management challenges in the pharmaceutical industry - the integration of the cost-efficacy thresholds introduced in the public reimbursement of medicine across several European countries into model-informed R&D with multiple technical and commercial risks by accounting for the stochastic jump dynamics of product efficacy. Our methodological contribution is threefold. First, we introduce an efficacy-dependent compound real option valuation method based on a lattice Lévy model to provide an efficacy-driven product development roadmap of project risk profiles. Second, we develop a novel procedure for estimating conditional stage transition probabilities, enabling the calibration of underlying model parameters using historical stage transition frequencies at the industry or company level. Third, we present a new decision tool to balance expected value against sunk costs, with a focus on meeting efficacy thresholds.