New Compound Real Option Pricing Method with Lévy Processes for the Quality-by-Design Pharmaceutical R&D

Abstract

We present a new generation of the compound real option pricing model with the quality-by-design methodology to evaluate multistage R&D projects under multiple pharmacology shocks based on Lévy processes. The proposed model tackles multiple urgent R&D valuation and management challenges in the development of new medicine, such as (i) the integration of cost-efficacy thresholds in the public reimbursement of medicine; (ii) a rigorous foundation for model-informed drug development with a real time incorporation of technical and commercial shocks, (iii) a realistic modelling of the stochastic jump dynamics of new product efficacy with Lévy processes in lengthy pharmaceutical R&D, and (iv) paying attention to such risk dimensions as expected losses, which were often omitted in the literature.

Keywords: compound real option, Lévy processes, pharmaceutical R&D, cost-efficacy thresholds, value-based pricing

JEL Classification: G12, G13, G17, G32, O32, C44, C63, D81