This paper shows that the conditionality of investment decisions in R&D has a critical impact on portfolio risk, and implies that traditional diversification strategies should be reevaluated when a portfolio is constructed. Real option theory argues that research projects have conditional or option-like risk and return properties, and are different from unconditional projects. Although the risk of a portfolio always depends on the correlation between projects, a portfolio of conditional R&D projects with real option characteristics has a fundamentally different risk than a portfolio of unconditional projects. When conditional R&D projects are negatively correlated, diversification only slightly reduces portfolio risk. When projects are positively correlated, however, diversification proves more effective than conventional tools predict.

Additional Metadata
Keywords portfolio analysis, real options, research & development
JEL Firm Behavior (jel D21), Firm Objectives, Organization, and Behavior: General (jel L20), Business Administration and Business Economics; Marketing; Accounting (jel M), Innovation and Invention: Processes and Incentives (jel O31), Management of Technological Innovation and R&D (jel O32)
Publisher Erasmus Research Institute of Management (ERIM)
Persistent URL hdl.handle.net/1765/15410
Citation
van Bekkum, S, Pennings, H.P.G, & Smit, J.T.J. (2009). A Real Options Perspective On R&D Portfolio Diversification (No. ERS-2009-019-STR). ERIM report series research in management Erasmus Research Institute of Management. Erasmus Research Institute of Management (ERIM). Retrieved from http://hdl.handle.net/1765/15410