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Valuation of sequential R&D investment under technological, market, and rival preemption uncertainty

  • Michi Nishihara

    ()

    (Graduate School of Economics, Osaka University)

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    We develop a real options model for evaluating and optimizing an R&D project. The model can capture key features of R&D, including research duration, growth opportunity, debt financing, and uncertainty of technological, demand market, and rival preemption. Nevertheless, it is computationally tractable and thus helps practitioners to evaluate various cases of R&D investment. Further, by analyzing the model with a wide range of parameter values, we unveil the interactions of key R&D features. The effect of duration on investment depends on whether there is a possibility of rival preemption. Higher uncertainty of research duration speeds up project inception in the presence of rival preemption. Higher uncertainty of technological success, combined with a growth opportunity embedded in the R&D project, accelerates investment. Debt financing can greatly decrease time lag between the first stage project and growth project. These results are consistent with the empirical evidence.

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    File URL: http://www2.econ.osaka-u.ac.jp/library/global/dp/1413.pdf
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    Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 14-13.

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    Length: 28 pages
    Date of creation: Apr 2014
    Date of revision:
    Handle: RePEc:osk:wpaper:1413
    Contact details of provider: Web page: http://www.econ.osaka-u.ac.jp/
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    5. Nishihara, Michi & Shibata, Takashi, 2013. "The effects of external financing costs on investment timing and sizing decisions," Journal of Banking & Finance, Elsevier, vol. 37(4), pages 1160-1175.
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    7. Ariel Pakes & Mark Schankerman, 1984. "The Rate of Obsolescence of Patents, Research Gestation Lags, and the Private Rate of Return to Research Resources," NBER Chapters, in: R&D, Patents, and Productivity, pages 73-88 National Bureau of Economic Research, Inc.
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    9. Driver, Ciaran & Temple, Paul & Urga, Giovanni, 2008. "Real options -- delay vs. pre-emption: Do industrial characteristics matter?," International Journal of Industrial Organization, Elsevier, vol. 26(2), pages 532-545, March.
    10. 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.
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    13. Guthrie, Graeme, 2009. "Real Options in Theory and Practice," OUP Catalogue, Oxford University Press, number 9780195380637, March.
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