Article ID: | iaor20133330 |
Volume: | 212 |
Issue: | 2 |
Start Page Number: | 374 |
End Page Number: | 385 |
Publication Date: | Jul 2011 |
Journal: | European Journal of Operational Research |
Authors: | Pennings Enrico, Sereno Luigi |
Keywords: | pharmaceutical industry, research and development |
This study sets up a compound option approach for evaluating pharmaceutical R&D investment projects in the presence of technical and economic uncertainties. Technical uncertainty is modeled as a Poisson jump that allows for failure and thus abandonment of the drug development. Economic uncertainty is modeled as a standard diffusion process which incorporates both up‐and downward shocks. Practical application of this method is emphasized through a case analysis. We show that both uncertainties have a positive impact on the R&D option value. Moreover, from the sensitivity analysis, we find that the sensitivity of the option with respect to economic uncertainty and market introduction cost decreases when technical uncertainty increases.