Risk Premia and Premption in R&D Ventures
47 Pages Posted: 8 Oct 2000
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: Suggested Citation