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A real options perspective on R&D portfolio diversification

  • van Bekkum, Sjoerd
  • Pennings, Enrico
  • Smit, Han

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://www.sciencedirect.com/science/article/B6V77-4W91CJ3-1/2/6102e9b35cabb08dcd64423139c713be
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Article provided by Elsevier in its journal Research Policy.

Volume (Year): 38 (2009)
Issue (Month): 7 (September)
Pages: 1150-1158

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Handle: RePEc:eee:respol:v:38:y:2009:i:7:p:1150-1158
Contact details of provider: Web page: http://www.elsevier.com/locate/respol

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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.
  2. Hartmann, Marcus & Hassan, Ali, 2006. "Application of real options analysis for pharmaceutical R&D project valuation--Empirical results from a survey," Research Policy, Elsevier, vol. 35(3), pages 343-354, April.
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