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RFS Advance Access published online on August 11, 2003
Review of Financial Studies, doi:10.1093/rfs/hhg021
Review of Financial Studies © The Society for Financial Studies 2003; all rights reserved
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© 2003 The Society for Financial Studies

Original Articles

Valuation and Return Dynamics of New Ventures

Jonathan B. Berk 1*, Richard C. Green 2, and Vasant Naik 3
1 Haas School of Business, University of California, Berkeley; NBER
2 Graduate School of Industrial Administration, Carnegie Mellon University
3 Lehman Brothers

* To whom correspondence should be addressed. E-mail: berk{at}haas.berkeley.edu.


  Abstract

A dynamic model of a multi-stage investment project that captures many features of R&D ventures and start-up companies is developed. An important feature these problems share is that firms learn about the potential profitability of the project throughout its life, but that technical uncertainty about the R&D effort is only resolved through additional investment. Consequently, the risks associated with the ultimate cash flows have a systematic component even while the purely technical risks are idiosyncratic. Our model captures these different sources of risk, and allows us to study their interaction in determining the value and risk premium of the venture.


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