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Valuation and Return Dynamics of New Ventures


  • Jonathan B. Berk
  • Richard C. Green
  • Vasant Naik


We develop and analyze a model of a multi-stage investment project that captures many features of R&D ventures and start-up companies. An important feature these problems share is that the firm learns about the potential profitability of the project throughout its life, but that research and development effort itself is only resolved through additional investment by the firm. In addition, the risks associated with the ultimate cash flows the firm realizes on completion of the project have a systematic component, while the purely technical risks are idiosyncratic. Our model captures these different sources of risk, and allows us to study their interaction in determining the risk premia earned by the venture during development. Our results show that the systematic risk, and the required risk premium, of the venture are highest early in its life, and decrease as it approaches completion, despite the idiosyncratic nature of the technical risk.

Suggested Citation

  • Jonathan B. Berk & Richard C. Green & Vasant Naik, 1998. "Valuation and Return Dynamics of New Ventures," NBER Working Papers 6745, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6745
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    References listed on IDEAS

    1. Pindyck, Robert S., 1993. "Investments of uncertain cost," Journal of Financial Economics, Elsevier, vol. 34(1), pages 53-76, August.
    2. 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.
    3. Dasgupta, Partha & Maskin, Eric, 1987. "The Simple Economics of Research Portfolios," Economic Journal, Royal Economic Society, vol. 97(387), pages 581-595, September.
    4. Dutta, Prajit K., 1997. "Optimal management of an R&D budget," Journal of Economic Dynamics and Control, Elsevier, vol. 21(2-3), pages 575-602.
    5. Pakes, Ariel S, 1986. "Patents as Options: Some Estimates of the Value of Holding European Patent Stocks," Econometrica, Econometric Society, vol. 54(4), pages 755-784, July.
    6. Gruver, Gene W., 1991. "Optimal R&D policy for a patent race with uncertain duration," Mathematical Social Sciences, Elsevier, vol. 22(1), pages 69-85, August.
    7. Weitzman, Martin L, 1979. "Optimal Search for the Best Alternative," Econometrica, Econometric Society, vol. 47(3), pages 641-654, May.
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    Cited by:

    1. Didier Cossin & BenoƮt Leleux & Entela Saliasi, 2002. "Understanding the Economic Value of Legal Covenants in Investment Contracts: A Real-Options Approach to Venture Equity Contracts," Swiss Finance Institute Research Paper Series rp63, Swiss Finance Institute.
    2. Davis, Graham A. & Owens, Brandon, 2003. "Optimizing the level of renewable electric R&D expenditures using real options analysis," Energy Policy, Elsevier, vol. 31(15), pages 1589-1608, December.
    3. Smit, Han T.J. & Trigeorgis, Lenos, 2006. "Real options and games: Competition, alliances and other applications of valuation and strategy," Review of Financial Economics, Elsevier, vol. 15(2), pages 95-112.

    More about this item

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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