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Sharing R&D Risk in Healthcare via FDA Hedges

51 Pages Posted: 3 Apr 2017 Last revised: 13 Apr 2017

Adam Tejs Jørring

University of Chicago - Booth School of Business

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Tomas Philipson

University of Chicago; National Bureau of Economic Research (NBER)

Manita Singh

Goldman Sachs

Richard T. Thakor

University of Minnesota - Carlson School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: March 28, 2017

Abstract

The high cost of capital for firms conducting medical research and development (R&D) has been partly attributed to the government risk facing investors in medical innovation. This risk slows down medical innovation because investors must be compensated for it. We propose new and simple financial instruments, Food and Drug Administration (FDA) hedges, to allow medical R&D investors to better share the pipeline risk associated with FDA approval with broader capital markets. Using historical FDA approval data, we discuss the pricing of FDA hedges and mechanisms under which they can be traded and estimate issuer returns from offering them. Using various unique data sources, we find that FDA approval risk has a low correlation across drug classes as well as with other assets and the overall market. We argue that this zero-beta property of scientific FDA risk could be a main source of gains from trade between issuers of FDA hedges looking for diversified investments and developers looking to offload the FDA approval risk. We offer proof of concept of the feasibility of trading this type of pipeline risk by examining related securities issued around mergers and acquisitions activity in the drug industry. Overall, our argument is that, by allowing better risk sharing between those investing in medical innovation and capital markets more generally, FDA hedges could ultimately spur medical innovation and improve the health of patients.

Keywords: Healthcare Finance, R&D Investments, Drug Development, FDA Approval, Idiosyncratic Risk, Risk sharing, Hedging

JEL Classification: G11, G12, G13, G22, G23, G31, I18, K23, L65, O32

Suggested Citation

Jørring, Adam Tejs and Lo, Andrew W. and Philipson, Tomas and Singh, Manita and Thakor, Richard T., Sharing R&D Risk in Healthcare via FDA Hedges (March 28, 2017). MIT Sloan Research Paper No. 5194-17. Available at SSRN: https://ssrn.com/abstract=2944258

Adam Jørring

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Andrew Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

Tomas Philipson

University of Chicago ( email )

Graduate School of Business
1101 East 58th Street
Chicago, 60637

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Manita Singh

Goldman Sachs ( email )

Richard Thakor (Contact Author)

University of Minnesota - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

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