Risk and Reward in the Orphan Drug Industry

26 Pages Posted: 16 Oct 2018

See all articles by Andrew W. Lo

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)

Richard T. Thakor

University of Minnesota - Carlson School of Management

Date Written: September 24, 2018

Abstract

Thanks to a combination of scientific advances and economic incentives, the development of therapeutics to treat rare or “orphan” diseases has grown dramatically in recent years. With the advent of FDA-approved gene therapies and the promise of gene editing, many experts believe we are at an inflection point in dealing with these afflictions. In this paper we propose to document this inflection point by measuring the risk and reward of investing in the orphan drug industry. We construct a stock market index of 39 publicly traded companies that specialize in developing drugs for orphan diseases and compare the financial performance of this index, which we call ORF, to the broader biopharmaceutical industry as well as the overall stock market from 2000 to 2015. While ORF underperformed other biopharma companies and the overall stock market in the early 2000s, its performance has improved over time: from 2010 to 2015, ORF returned 608%, far exceeding the returns of 317%, 320%, and 305% of the S&P, NASDAQ, and NYSE/ARCA Biotech indexes, respectively, and the 83% of the S&P 500. ORF does have higher volatility than the other indexes, but still outperforms even on a risk-adjusted basis, with a Sharpe ratio of 1.24 versus Sharpe ratios of 1.17, 1.14, and 1.05, respectively for the other three biotech indexes, and 0.71 for the S&P 500. However, ORF has a market beta of 1.16 which suggests significant correlation to the aggregate stock market and less diversification benefits than traditional pharmaceutical investments.

Keywords: Risk, Return, Index, Biopharmaceutical Industry, Orphan Drugs, Drug Development

JEL Classification: G11, G12, L65, O32

Suggested Citation

Lo, Andrew W. and Thakor, Richard T., Risk and Reward in the Orphan Drug Industry (September 24, 2018). MIT Sloan Research Paper No. 5582-18. Available at SSRN: https://ssrn.com/abstract=3254586 or http://dx.doi.org/10.2139/ssrn.3254586

Andrew W. Lo (Contact Author)

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

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National Bureau of Economic Research (NBER) ( email )

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

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Cambridge, MA 02142
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Richard T. Thakor

University of Minnesota - Carlson School of Management ( email )

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Minneapolis, MN 55455
United States

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