Starting an R&D Project Under Uncertainty
Tinbergen Institute Discussion Paper 2009-044/3
29 Pages Posted: 22 May 2009
Date Written: May 18, 2009
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.
Keywords: investment under uncertainty, R&D, demand uncertainty, technical uncertainty, entry threat
JEL Classification: D21, D81, L12, O31
Suggested Citation: Suggested Citation