Valuation of R&D Investment Opportunities Using the Least-Squares Monte Carlo Method

In this paper we show the applicability of the Least Squares Monte Carlo (LSM) in valuing R&D investment opportunities. As it is well known, R&D projects are made in a phased manner, with the commencement of subsequent phase being dependent on the successful completion of the preceding phase. This is known as a sequential investment and therefore R&D projects can be considered as compound options. Moreover, R&D investments often involve considerable cost uncertainty so that they can be viewed as an exchange option, i.e. a swap of an uncertain investment cost for an uncertain gross project value. In this context, the LSM method is a powerful and flexible tool for capital budgeting decisions and for valuing R&D investments. In fact, this method provides an efficient technique to value complex real investments involving a set of interacting American-type options