Evaluating R&D Projects with Hedging Behavior

A Dynamic Programming approach for evaluating a portfolio of R&D projects with a budget

“…Therefore the value of decision flexibility in a R&D project (that is, the value of an option on a R&D project) can be substantial [3,5]. The two types of uncertainty influence differently the value of flexibility underlying a R&D project.…”

“…Since the underlying asset of the option on the R&D project is not traded, the respective market value cannot be determined [8]. For this reason, the contingent claims analysis, which is based on the principle of replication, should not be applied to evaluate R&D projects [3]. An alternative technique for evaluating real options is dynamic programming, which is not based on the principle of replication of the risks of the underlying asset [4,9].…”

“…On the other hand, the risk associated with a R&D project is normally attributed to the intrinsic characteristics of the project, that is, the risk is unsystematic or diversifiable. In this way, many researchers argue that a reasonable hypothesis for a large company is a neutral attitude to the risk of the project with the discounted process at the risk-free interest rate [1,3,4,9,10].…”

“…These projects should be viewed as a collection of sequential decisions, which involve a R&D phase, multi-stage, and a commercialization phase, with different risks and uncertainties, which will decreasing as the project develops [2,3].…”

“…Specifically, after an initial investment it is possible collect more information on the evolution of the project and market conditions and, based on this information, modify the action plan [1,[3][4][5][6][7].…”