Patents as Real Options: A Sensitivity Analysis of Option Valuation Using the Binomial Model

Abstract

Using the real option approach and the binomial decision tree model, patent value is discussed in terms of how patent protection gives firms flexibility in making investment decisions on whether or how to continue exploiting the underlying invention in the commercialisation phase. The results of this paper, in agreement with predictions of current financial theory, indicate that patent real option value increases when the following input factor conditions exist: increased patent asset value, longer time to the expiration of patent protection, higher interest rates, larger variability of future values of the patent asset, decreased patent commercialisation investment, and lower cost of delay in commercialisation investment decisions. Furthermore, patent real option value sensitivities are estimated 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.