Dynamic investment strategies for a risky R and D project

Abstract

During the course of an R and D project, it is often meaningful and possible to evaluate its status, so that this information may be used for making better financing decisions over time. The project status changes stochastically due to the internal (technological) and the external (market) uncertainties, the former being partially controlled by expenditure of resources. In addition to the resource expenditure strategy, the manager must also decide when to terminate the project. Once the project is terminated, a terminal return is collected, whose value depends on the final project status. It is shown that the project should be terminated if the current status is either too low or too high to make further expenditure worthwhile. Otherwise, for an intermediate (promising) status of the project, an aggressive investment strategy is shown to be optimal. Thus, the model unifies the problems of optimally undertaking, financing and terminating an R and D project in face of various uncertainties.