Sharing R&D Risk in Healthcare via FDA Hedges

Abstract

Abstract Biomedical innovation suffers from a “funding gap” between the needs of drug development firms and the availability of funds. The requirement of large investments for drug development projects and the high pipeline risk associated with FDA approval causes this funding gap in part. In this paper, we propose a new financial instrument—the “FDA hedge”—that pays off upon FDA approval failure. We develop a theory to show that the FDA hedge can help eliminate the funding gap. Using novel project-level data, we establish empirically that FDA hedge risk is idiosyncratic, and show how better sharing this risk can spur welfare-enhancing R&D. (JEL G11, G13, G22, I11, L65, O32 Received November 30, 2020; editorial decision September 23, 2021 by Editor Andrew Ellul. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.