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Risk Premia and Preemption in R&D Ventures

Published online by Cambridge University Press:  06 April 2009

Lorenzo Garlappi
Lorenzo Garlappi
Affiliation:
lorenzo.garlappi@mccombs.utexas.edu, McCombs School of Business, The University of Texas at Austin, Austin, TX 78712
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Abstract

I analyze the impact of competition on the risk premia of R&D ventures engaged in a multiple-stage patent race with technical and market uncertainty. After solving in closed form for the case of a two-stage race in continuous time, I show that a firm's risk premium decreases as a consequence of technical progress and increases when a rival pulls ahead. Compared to the case where firms collude, R&D competition erodes the option value to mothball a project, reduces the completion time and the failure rate of R&D, and causes higher and more volatile risk premia. Numerical simulations reveal that competition can generate risk premia up to 500 annual basis points higher and up to three times more volatility than in a collusive industry.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 39 , Issue 4 , December 2004 , pp. 843 - 872
Copyright
Copyright © School of Business Administration, University of Washington 2004

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