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

Whalley, A. Elizabeth, Optimal R&D Investment for a Risk-Averse Entrepreneur (September 30, 2008). WBS Finance Group Research Paper No. 109, Available at SSRN: https://ssrn.com/abstract=1340673 or http://dx.doi.org/10.2139/ssrn.1340673

A. Elizabeth Whalley (Contact Author)

University of Warwick - Finance Group ( email )

Warwick Business School
University of Warwick
Coventry, CV4 7AL
Great Britain

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