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Production of a New Drug: A Sequential Investment ProcessUnder Uncertainty

Author

Listed:
  • Marcello Basili

    ()

  • Roberto Renò

    ()

  • Carlo Zappia

    ()

Abstract

On the basis of a database of more than 80 thousand records on total retails and production costs of the pharmaceutical industry worldwide we consider four classes of drugs. We evaluate the expected profits of an investment in a new drug in the four classes of pharmaceutical products by considering the standard NPV evaluation. We compare these outcomes with the evaluation of the expected profits of the four new drugs obtained by the real option approach. Interestingly enough quite different outcomes are obtained. These results loom on the capacity of standard methods to give a reliable evaluation of real investment projects that are analogous to compound options

Suggested Citation

  • Marcello Basili & Roberto Renò & Carlo Zappia, 2005. "Production of a New Drug: A Sequential Investment ProcessUnder Uncertainty," Department of Economics University of Siena 453, Department of Economics, University of Siena.
  • Handle: RePEc:usi:wpaper:453
    as

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    File URL: http://repec.deps.unisi.it/quaderni/453.pdf
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    References listed on IDEAS

    as
    1. Pindyck, Robert S., 1993. "Investments of uncertain cost," Journal of Financial Economics, Elsevier, vol. 34(1), pages 53-76, August.
    2. Gene M. Grossman & Carl Shapiro, 1986. "Optimal Dynamic R&D Programs," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 581-593, Winter.
    3. 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.
    4. DiMasi, Joseph A. & Hansen, Ronald W. & Grabowski, Henry G. & Lasagna, Louis, 1991. "Cost of innovation in the pharmaceutical industry," Journal of Health Economics, Elsevier, vol. 10(2), pages 107-142, July.
    5. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
    6. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    7. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
    8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    9. DiMasi, Joseph A. & Hansen, Ronald W. & Grabowski, Henry G., 2003. "The price of innovation: new estimates of drug development costs," Journal of Health Economics, Elsevier, vol. 22(2), pages 151-185, March.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    compound option; real option valuation; net present value; drugs;

    JEL classification:

    • O3 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights
    • L65 - Industrial Organization - - Industry Studies: Manufacturing - - - Chemicals; Rubber; Drugs; Biotechnology; Plastics
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing

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