OBJECTIVES: To scale up investment and spread risks of pharmaceutical R&D at the level of individual projects, we have developed a new methodology for valuation of compound real call options by R&D stages. We propose transparent mechanisms and fair product valuation formulas to enable pharmaceutical companies to issue and trade call options on each drug R&D stage.

METHODS: One of the principal features of the proposed business model is that we put new drug efficacy at the centre of the entire R&D process as the main target parameter guiding the value and approval of new drug. We model new drug efficacy dynamics with jump processes and provide a road map of expected losses and success probabilities for each R&D stage depending on current drug candidate efficacy. The model allows to control the ratio of the compound R&D option value to the expected losses with pre-set efficacy thresholds. The approach incorporates multiple technological and commercial shocks in line with the value-for-money R&D framework.

RESULTS: We have derived an iterative formula for estimation of issue volume and fair price of the proposed real call options for individual pharmaceutical R&D project by stages depending on R&D results delivered in real time. We numerically demonstrate viability of the proposed compound call options for a typical industry R&D project.

CONCLUSIONS: The stage R&D real call options can provide an attractive solution for the deficiency of R&D financing, as well as to share risks. After successful completion of the current stage, drug developers issue additional compound call options in a volume sufficient to cover expenses at the next stage. Moreover, early-stage investors may resell compound call options to other investors at later stages, receiving significant profits if the R&D project is successful. Developers get funding for the next phase if the drug being developed demonstrates safety and high efficacy.