Real Options Valuation Under Uncertainty
42 Pages Posted: 20 Aug 2015
Date Written: August 19, 2015
In this paper we develop a novel valuation model and methodology to value a pharmaceutical R&D project based on real options approach. The real options approach enables the possibility of optimally abandon the project before completion whenever the investment cost turns out to be larger than the expected net cash flow stream. On the other hand, the proposed model accounts for two different sources of uncertainty, those are technical and economic risk. This model incorporates a novel economic state vector where each economic state captures the interaction among different market and economic forces using Fourier series as the particular basis for the economic function space. In this sense, Fourier series are considered as an aggregate of forces playing a relevant role in the process evolution determining the cash flow structure and also allowing us to properly define an economic scenario where the project will be developed.
Keywords: Real options, R&D, Economic risk, Fourier series, Pharmaceutical industry, Risk factor
JEL Classification: G12, G17, G32, C22, C63
Suggested Citation: Suggested Citation