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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.

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File URL: http://www.nber.org/papers/w6745.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6745.

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Date of creation: Oct 1998
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Publication status: published as Jonathan B. Berk, 2004. "Valuation and Return Dynamics of New Ventures," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(1), pages 1-35.
Handle: RePEc:nbr:nberwo:6745
Note: AP
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  1. Ariel Pakes, 1986. "Patents as Options: Some Estimates of the Value of Holding European Patent Stocks," NBER Working Papers 1340, National Bureau of Economic Research, Inc.
  2. 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.
  3. M. L. Weitzman, 1978. "Optimal Search for the Best Alternative," Working papers 214, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Saman Majd & Robert S. Pindyck, 1985. "Time to Build, Option Value, and Investment Decisions," NBER Working Papers 1654, National Bureau of Economic Research, Inc.
  5. Robert S. Pindyck, 1992. "Investments of Uncertain Cost," NBER Working Papers 4175, National Bureau of Economic Research, Inc.
  6. Dasgupta, Partha & Maskin, Eric, 1987. "The Simple Economics of Research Portfolios," Economic Journal, Royal Economic Society, vol. 97(387), pages 581-95, September.
  7. 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.
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