'Real options' framework to assess public research investments

Abstract

This paper deals with R&D priority setting. It advocates the introduction of strategic capital budgeting methodologies that will unite the hitherto largely independent processes of strategic planning and capital budgeting. Significant advances in economics and finance theory regarding valuing derivative securities, such as futures and options, and in computing power over the past 20 years make it feasible now to capture in explicit analytical terms the flexibility inherent in active strategy and management of R&D resources. R&D strategies can now be analyzed as chains of ‘real options’. The methodology can, in principle, be applied to all kinds of research investments, including longer-term, more basic research.