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Incorporating technical risk in compound real option models to value a pharmaceutical R&D licensing opportunity

Author

Listed:
  • Cassimon, D.
  • De Backer, M.
  • Engelen, P.J.
  • Van Wouwe, M.
  • Yordanov, V.

Abstract

The valuation of multi-staged pharmaceutical R&D can be interpreted as a chain of real options. In valuing these compound option models, a crucial problem is how to deal with the different types of risk. Previous models, such as Cassimon et al. (2004), offer a closed-form solution for the valuation of a new drug development using a generalized n-fold compound option model, but implicitly bundle both commercial and technical risk in one risk measure. We extend this model by explicitly incorporating technical risk, while still preserving the closed-form solution of the model. As such, this extended model is better suited to handle real-life valuation cases in the pharmaceutical industry. We document the theoretical model with a real-life project of a major pharmaceutical multinational.

Suggested Citation

  • Cassimon, D. & De Backer, M. & Engelen, P.J. & Van Wouwe, M. & Yordanov, V., 2011. "Incorporating technical risk in compound real option models to value a pharmaceutical R&D licensing opportunity," Research Policy, Elsevier, vol. 40(9), pages 1200-1216.
    • Handle: RePEc:eee:respol:v:40:y:2011:i:9:p:1200-1216
    DOI: 10.1016/j.respol.2011.05.020
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    References listed on IDEAS

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    More about this item

    Keywords

    Pharmaceutical R&D; Real options; Compound option model; Technical risk; Case study;
    All these keywords.

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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