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 di¤usion 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 …nd that the sensitivity of the option with respect to economic uncertainty and market introduction cost decreases when technical uncertainty increases.

G13, G24, G30, R&D, compound option, jump-discussion process, pharmaceutical industry
Mathematical Methods and Programming (jel C6), Firm Behavior (jel D21), Firm Objectives, Organization, and Behavior: General (jel L20), Business Administration and Business Economics; Marketing; Accounting (jel M), Management of Technological Innovation and R&D (jel O32)
Erasmus Research Institute of Management
hdl.handle.net/1765/18211
ERIM Report Series Research in Management
ERIM report series research in management Erasmus Research Institute of Management
Erasmus Research Institute of Management

Pennings, H.P.G, & Sereno, L. (2010). A Model for Evaluating Pharmaceutical R&D Investment Projects under Technical and Economic Uncertainties (No. ERS-2010-009-STR). ERIM report series research in management Erasmus Research Institute of Management. Erasmus Research Institute of Management. Retrieved from http://hdl.handle.net/1765/18211