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.

portfolio analysis, real options, research & development
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)
Erasmus Research Institute of Management
hdl.handle.net/1765/15410
ERIM Report Series Research in Management
ERIM report series research in management Erasmus Research Institute of Management
Erasmus Research Institute of Management

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. Retrieved from http://hdl.handle.net/1765/15410