Risk Premia and Premption in R&D Ventures

47 Pages Posted: 8 Oct 2000

See all articles by Lorenzo Garlappi

Lorenzo Garlappi

University of British Columbia (UBC) - Sauder School of Business

Date Written: April 2000


I analyze the impact of competition on the risk premia of R&D ventures engaged in a multiple-stage patent race with technical and market uncertainty. After solving in closed-form for the case of a two-stage race in continuous-time, I show that a firm's risk premium decreases as a consequence of technical progress and increases when a rival pulls ahead in the race. Compared to the case where firms collude, R&D competition (i) erodes the option value to mothball a project (ii) reduces the completion time and the failure rate of R&D and (iii) causes higher and more volatile in risk premia. Numerical simulations reveal that competition can generate risk premia up to 500 annual basis point higher and up to three times more volatile than in a collusive industry.

Keywords: Real options, R&D investments, risk premia, patent races, stochastic games

JEL Classification: C73, G12, G31

Suggested Citation

Garlappi, Lorenzo, Risk Premia and Premption in R&D Ventures (April 2000). EFA 2000 Meetings Paper No. 0221; AFA 2001 New Orleans Meetings. Available at SSRN: https://ssrn.com/abstract=243671 or http://dx.doi.org/10.2139/ssrn.243671

Lorenzo Garlappi (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2

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