Starting an R&D Project Under Uncertainty
Roland Iwan Luttens
Ghent University - Department of Social Economics
Center for European Economic Research (ZEW)
VU University of Amsterdam - Department of Economics; Tinbergen Institute; Institute for the Study of Labor (IZA)
May 18, 2009
Tinbergen Institute Discussion Paper 2009-044/3
We study a two-stage R&D project with an abandonment option. Two types of uncertainty influence the decision to start R&D. Demand uncertainty is modelled as a lottery between a proportional increase and decrease in demand. Technical uncertainty is modelled as a lottery between a decrease and increase in the cost to continue R&D. We relate differences in uncertainty to differences in risk premia. We deduct testable hypotheses on the basis of which we empirically analyze the impact of uncertainty on the decision to start an R&D project. Using data for about 4000 German firms in manufacturing and services (CIS IV), our model predictions are strongly confirmed.
Number of Pages in PDF File: 29
Keywords: investment under uncertainty, R&D, demand uncertainty, technical uncertainty, entry threat
JEL Classification: D21, D81, L12, O31working papers series
Date posted: May 22, 2009
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