Optimal R&D Investment for a Risk-Averse Entrepreneur
45 Pages Posted: 11 Feb 2009
Date Written: September 30, 2008
Abstract
The technical uncertainty associated with the cost to completion of an R&D project, whilst idiosyncratic, is also inherently unhedgeable. We extend existing real options models of R&D investment to incorporate the cost of bearing this unhedgeable risk and find it decreases risk-averse entrepreneurs' valuations of R&D projects and increases the minimum NPVs required for continued investment in R&D (threshold NPVs) relative to 'unpriced risk' values and threshold NPVs, by more for larger projects and more risk-averse entrepreneurs. Overall, threshold NPVs for risk-averse entrepreneurs can be positive or negative and can increase or decrease with technical uncertainty depending on risk aversion and project size.
Keywords: R&D, technical uncertainty, entrepreneurial investment, cost of unhedgeable risk, utility maximisation
JEL Classification: G11, G13, G31, L26
Suggested Citation: Suggested Citation
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