Real options valuation under uncertainty

In this paper we develop a novel valuation model and methodology to value a pharmaceutical
R&D project based on real options approach. The real options approach enables the possibility
of optimally abandon the project before completion whenever the investment cost turns out to be
larger than the expected net cash flow stream. On the other hand, the proposed model accounts
for two different sources of uncertainty, those are technical and economic risk. This model incor-
porates a novel economic state vector where each economic state captures the interaction among
different market and economic forces using Fourier series as the particular basis for the economic
function space. In this sense, Fourier series are considered as an aggregate of forces playing a
relevant role in the process evolution determining the cash flow structure and also allowing us to
properly define an economic scenario where the project will be developed.