A Sensitivity Analysis of the Patent Real Option Valuation Using the Binomial Model

Abstract

Using the real option approach and the binomial decision tree model the paper appraises patent value in terms of the investment decision flexibility—conferred by patent protection—toward continued exploitation of the underlying invention in the commercialization phase. Consistently with the predictions of financial theory the paper reports that patent real option value increases with increasing patent asset value, decreasing patent commercialization investment, larger variability of future values of the patent asset, longer time to expiration of patent protection, lower cost of delay in commercialization investment decisions, and higher level of interest rate. Furthermore, the paper estimates patent real option value sensitivities for each of these input factors of the binomial decision tree model. More broadly, the paper provides a novel valuation tool for the monetary appraisal of patents and contributes to the IP literature on devising timely indicators of innovative activities.