Evaluating pharmaceutical R&D under technical and economic uncertainty

Evaluating pharmaceutical R&D under technical and economic uncertainty

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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: ,
Keywords: pharmaceutical industry, research and development
Abstract:

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.

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