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Budgeting Capital For R & D: An Application Of Option Pricing, John W. Kensinger

Historical Working Papers

This paper presents the insight that R&R investments are "natural" options, and examines the extent to which they can be valued using currently available option pricing models. The nature of the industrial research effort determines whether the appropriate model is based on a diffusion process or a jump process. The option model based on the former is sufficiently developed to satisfactorily deal with the direct benefits of R&D, while the model base on the latter presents several problems. Furthermore, indirect benefits are not captured in these models. These applications and shortcomings are examined in detail in the hope of not …