Working Paper: NBER ID: w10041
Authors: Jason C. Hsu; Eduardo S. Schwartz
Abstract: We develop a real options model of R&D valuation, which takes into account the uncertainty in the quality of the research output, the time and cost to completion, and the market demand for the R&D output. The model is then applied to study the problem of pharmaceutical under-investment in R&D for vaccines to treat diseases affecting the developing regions of the world. To address this issue, world organizations and private foundations are willing to sponsor vaccine R&D, but there is no consensus on how to administer the sponsorship effectively. Different research incentive contracts are examined using our valuation model. Their effectiveness is measured in the following four dimensions: cost to the sponsor, the probability of development success, the consumer surplus generated and the expected cost per person successfully vaccinated. We find that, in general, purchase commitment plans (pull subsidies) are more effective than cost subsidy plans (push subsidies), while extending patent protection is completely ineffective. Specifically, we find that a hybrid subsidy constructed from a purchase commitment combined with a sponsor co-payment feature produces the best results in all four dimensions of the effectiveness measure.
Keywords: R&D Valuation; Research Incentives; Pharmaceutical Underinvestment; Vaccine Development
JEL Codes: G31; O32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| pull subsidies (H23) | vaccine development success (I15) |
| push subsidies (H23) | vaccine development success (I15) |
| hybrid subsidies (H23) | vaccine development success (I15) |
| extension of patent protection (O34) | R&D investment for vaccines (O32) |
| subsidy types (H20) | probability of successful vaccine development (C46) |
| subsidy types (H20) | associated costs (M41) |