Incorporating Technical Risk in Compound Real Option Models to Value a Pharmaceutical R&D Licensing Opportunity

16 Pages Posted: 12 Dec 2012 Last revised: 18 Apr 2013

Danny Cassimon

University of Antwerp - Institute for Development Policy and Management

Marianne De Backer

Johnson & Johnson

Peter-Jan Engelen

Utrecht University - Utrecht University School of Economics

Martine Van Wouwe

University of Antwerp - Department of Mathematics Statistics and Actuarial Sciences

Vilimir Yordanov

Independent

Date Written: October 1, 2010

Abstract

The valuation of multi-staged pharmaceutical R&D can be interpreted as a chain of real options. In valuing these compound option models, a crucial problem is how to deal with the different types of risk. Previous models, such as Cassimon et al. (2004), offer a closed-form solution for the valuation of a new drug development using a generalized n-fold compound option model, but implicitly bundle both commercial and technical risk in one risk measure. We extend this model by explicitly incorporating technical risk, while still preserving the closed-form solution of the model. As such, this extended model is better suited to handle real-life valuation cases in the pharmaceutical industry. We document the theoretical model with a real-life project of a major pharmaceutical multinational.

Keywords: Pharmaceutical R&D, Real options, Compound option model, Technical risk, Case study

JEL Classification: C6, G12, G24, G31

Suggested Citation

Cassimon, Danny and De Backer, Marianne and Engelen, Peter-Jan and Van Wouwe, Martine and Yordanov, Vilimir, Incorporating Technical Risk in Compound Real Option Models to Value a Pharmaceutical R&D Licensing Opportunity (October 1, 2010). Research Policy, Vol. 40, No. 9, November 2011. Available at SSRN: https://ssrn.com/abstract=2188009

Danny Cassimon

University of Antwerp - Institute for Development Policy and Management ( email )

Prinsstraat 13
Antwerpen, B-2000
Belgium

Marianne De Backer

Johnson & Johnson ( email )

New Brunswick, NJ 08933
United States

Peter-Jan Engelen (Contact Author)

Utrecht University - Utrecht University School of Economics ( email )

Kriekenpitplein 21-22
Adam Smith Building
Utrecht, 3584 EC
Netherlands

Martine Van Wouwe

University of Antwerp - Department of Mathematics Statistics and Actuarial Sciences ( email )

Prinsstraat 13
Antwerpen, B-2000
Belgium

Vilimir Yordanov

Independent ( email )

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