Hedging FDA Risk?

by on April 19, 2017 at 6:09 am in Economics, Law, Medicine | Permalink

In the words of a recent article, the FDA’s rejection of a recent drug application was a stunning setback. Stunning setbacks are by definition unpredictable and unpredictable risks aren’t correlated with other risks which means that they can be easily priced and bought and sold. The all-star team of Adam Jørring, Andrew W. Lo, Tomas J. Philipson, Manita Singh and Richard T. Thakor propose just this in Sharing R&D Risk in Healthcare via FDA Hedges.

The idea is to create FDA Hedges that pay out a fixed fee if a drug fails to be approved and zero otherwise. Pharmaceutical firms could then buy some of these contracts and reduce their risk exposure which in turn would increase their incentive to invest in R&D.

The idea is clever but firms and even more so firm owners already have many ways to diversify and its not clear what the value of an additional source of diversification is, even one that is more closely tuned to the firm’s profits. It’s also not clear how much additional R&D would be driven by offloading these risks. Pharmaceutical R&D is valuable, however, so even small increases in R&D are welcome even if more fundamental changes would be better. Prices in these markets would also provide useful information.

I also worry that we are asking a lot of FDA reviewers and firm insiders to keep their inside information private. Information about FDA approval decisions is already very valuable and there have been a few cases where insiders trade on their information or leak it to make millions. FDA Hedges might make this problem worse which should be balanced against the possible gains.

1 dearieme April 19, 2017 at 6:34 am

The problem with drug discovery is that there’s lots of effort but precious little success. I don’t suppose that The Answer lies in financial instruments.


2 Jan April 19, 2017 at 8:08 am

Correct. The low hanging fruit has been picked for most significant conditions. Drug companies increasingly focus on drugs for rarer conditions that have not been as thoroughly explored (good for those patients), increasing prices to maintain revenue, developing me too drugs that provide no clinical benefit over existing therapies, and fighting the concept that drugs should be reimbursed for based on any framework that takes into account cost effectiveness.


3 mulp April 19, 2017 at 12:55 pm

What evidence is there for drug companies investing in R&D for rare diseases?

Why don’t drug companies invest in R&D for very costly widespread disease which impacts hundreds of millions of people constantly?

Note that 95% plus of the patients in need of new drugs and vaccines are outside the reach of the FDA.

As far as I can tell, 90% of drug R&D is funded by public non-profits globally, and even in the US, very little is done by for profits.

And the public funding and risk, private profit for success, model that has been established in the US since circa 1980 has failed to increase the funding of R&D in real terms in the US, and failed to deliver needed drugs and vaccines faster, as promised in the 70s and 80s when the debate started impacting laws in Congress and in multiple States.

For example, vaccine production in 2000 was virtually identical to vaccine production in 1980, except the number of drug companies producing vaccines crashed from hundreds to a handful.

All the advances in vaccine production in recent years has resulted from government central planning and funding.

The most notable new vaccine type in the 21st century is for HPV which resulted from research by the German Harald zur Hausen in Germany, Françoise Barré-Sinoussi and Luc Montagnier, two French virologists in France, vaccine development by the University of Queensland in Australia, a and then public funding in the US, with the early vaccines approved outside the US in 2007, and with US priority patents granted to Queensland inventors, Merck got FDA expedited approval in 2006.

HPV vaccinations are publicly funded for girls in most of the British Empire and Europe since 2007-2010 with costs as low as $5, but in the US, the price is typically $120 a dose, thus $240 to $360 for the recommended treatment over multiple medical contacts. Evidence argues for vaccinating boys to gain a much higher benefit to cost. While the US offers lots of profit potential for expanding the number of people vaccinated and the viruses included, the US has much lower rates of vaccination.

And the highest profile advocate of widespread HPV vaccination is Gov Perry who advocated centrally planned and funded vaccination in Texas.

Vaccine manufacture has advanced only as a result of government central planning and production, starting in the DoD over fear of biologic weapons from al Qaeda and Sadam, expanded in reaction to several new flu strains striking fear, with funding from CDC, NIH, et al, and FDA making qualifying new manufacturing a top priority, and manufacturers promised guaranteed high volume sales at set prices for a number of years. Methods coming out of NIH and CDC experts selecting the most promising replacements to use of eggs.

These developments did not come out of the big global drug companies that could raise tens of billions in funding by selling shares of stock, just like Elon Musk funds new production by issuing and selling new shares of stock to raise capital to fund investments. Instead, the drug companies are more likely to use cash to buy outstanding shares of stock they issued years ago.


4 Nodnarb the Nasty April 19, 2017 at 8:10 am

I think you’re on to something here. How about a libertarian argument for an FDA?


5 Bill April 19, 2017 at 6:39 am

Information asymmetry makes this a bad bet.


6 Jack April 19, 2017 at 7:29 am

Yes. In fact, I suspect that the very act of seeking to publicly insure a drug against failure might be seen as a lack of confidence – and may actually be a lack of confidence.

If this model works, it seems it would be better done in secret and with a private entity that can enter into NDAs and other information sharing structure that reduce the asymmetry.


7 John April 19, 2017 at 8:00 am

Agreed. The information asymmetry and potential for abuse would almost certainly lead to an extremely illiquid market at best.

I wonder if companies could hedge themselves in a similar way in the public markets, since markets are already pricing in some probability weighted chance of FDA approval. A company could sell stock on the open market and buy it back post FDA announcement, realizing a profit or loss based on drug success. A company could also buy puts or sell calls to achieve a similar outcome. Granted, a company will open themselves to market noise in the meantime, and won’t be able to isolate the PNL associated with a specific drug, but I’m not sure if that is such a bad thing.


8 Picador April 19, 2017 at 10:06 am

Yes. Who is in a better situation to assess the risk than the drug developer itself? Why would anyone ever take a bet from a developer betting against its own drug?


9 Mark Thorson April 19, 2017 at 11:38 am

Absolutely agree. What hedge fund could possibly have an advantage or even parity when assessing risk.

On the other hand, there’s a similar situation with Hollywood movies. Years in development, tens or hundreds of millions spent, big gamble whether it will tank at the box office. A hedge fund could view early cuts or the finished film and make an assessment of the risk that is as good or better than that of the studio. I’ve never heard of that being done, however there is a current practice of sharing the risk by selling part ownership in a movie. I believe this sharing is usually done between studios. Perhaps there is an opportunity for a hedge fund to be created that specializes in movies — if they could assess risk better than the studios, they could offer a better deal.


10 carlospln April 19, 2017 at 4:26 pm

“Perhaps there is an opportunity for a hedge fund to be created that specializes in movies ..”

Its been done:



11 Axa April 19, 2017 at 6:48 am

Delay or failure in bringing a new drug or device to market is just 1 among many risks pharmaceutical companies face. For example, this is what Roche has identified as risks:

“Various factors may cause actual results to differ materially in the future from those reflected in forward-looking statements contained in this document, among others: (1) pricing and product initiatives of competitors; (2) legislative and regulatory developments and economic conditions; (3) delay or inability in obtaining regulatory approvals or bringing products to market; (4) fluctuations in currency exchange rates and general financial market conditions; (5) uncertainties in the discovery, development or marketing of new products or new uses of existing products, including without limitation negative results of clinical trials or research projects, unexpected side effects of pipeline or marketed products; (6) increased government pricing pressures; (7) interruptions in production; (8) loss of or inability to obtain adequate protection for intellectual property rights; (9) litigation; (10) loss of key executives or other employees; and (11) adverse publicity and news coverage.” https://www.six-swiss-exchange.com/issuers/services/tensid_news_en.html?id=0de0129a

New drug approval is not the only topic where governments have influence. Also regulations, pricing negotiations and intellectual property rights are important. What about negotiating the extent of a patent? If a drug is really important, regulators could concede patent protection for 1.5 or 2 times the normal period.


12 rayward April 19, 2017 at 6:59 am

To be clear, the FDA is requiring Eli Lilly “to provide more clinical data on the appropriate doses [for baricitinib] to be used for rheumatoid arthritis” as well as more safety data. But all is not lost, as baricitinib was approved in Europe — as Olumiant — “where it will be subjected to a single-payer review and significantly lower reimbursements”. Implicit is that the FDA is concerned that Eli Lilly may be exaggerating the required dosage in order to maximize sales – Lilly expects the drug to generate $2 billion in annul sales. That’s less of a concern in Europe where prices are much, much lower. High drug prices in America provide an incentive for exaggerating the dosage, the greed of the drug company often resulting in injury to the patient as well as excessive profits for the drug company.


13 mulp April 19, 2017 at 1:23 pm

Not so much exaggerating the dosage as exaggerating the benefits to increase sales to patients it will not benefit at prices hundreds of times the cost.

I find it so disturbing that increasingly economists pitch “price” as the true “cost” which increasingly diverge to extremes.

For example, health insurance prices and costs will fall if only government deregulated so insurers can deliver far more of the medical care insured patients want at lower prices due to competition driving down prices below costs of health care delivery. And by lower prices from deregulation, more jobs at higher pay will result in health care.

On the other hand, the Hepatitis C vaccine is “worth the $100,000 cost of the vaccine” so government should pay $100,000 to save treatment costs of liver disease. That the marginal cost of the vaccine is likely no more than $100 seems to be lost on today’s economists. Of course, Alex argues that eliminating the FDA and patent law changes since conservative Republicans got to increasingly set the policy direction to high profitschool as priority, will result in more new drugs as competition to grab the huge profits drive down prices and thus “destroy wealth” – ie, crater drug share prices.


14 Imanuel April 19, 2017 at 6:59 am

And who is the natural seller of this option? I guess you can get cyber attack insurance so why not FDA insurance. There is more reliable data on latter than former.


15 mulp April 19, 2017 at 1:52 pm

Your can buy the coverage today on the NASDAQ. Or in private equity.

For example, the risk of Elizabeth Holmes not getting FDA approval was mitigated by sales of Theronos interests for an estimated $400 million in its first decade of existence.

Holmes got FDA approval: “In July 2015, the Food and Drug Administration approved the use of the company’s fingerstick blood testing device for the herpes simplex virus (HSV-1) outside a clinical laboratory setting.” Of course, this FDA approval was not required for this product, and it seems the only reason Theranos sought FDA premarket approval was to market other products that did not work as advertised.

Theranos bought $400 million in insurance coverage. The sellers of this insurance lost their shirts when Theranos failed to produce products that could get unneeded FDA approval. Nor that met legal product fitness requirements.


16 prior_test2 April 19, 2017 at 7:10 am

Prof. Tabarrok is clearly close to apostasy when he writes – ‘ Information about FDA approval decisions is already very valuable and there have been quite a few cases where FDA insiders trade on their information or leak it to make millions’

Dean Manne, a previous dean of what is now currently known, after GMU received a stunningly generous 20 million dollar anonymous donation, as the Antonin Scalia Law School, and renowned law and economics scholar, made clear that insider trading was a thoroughly degraded concept. Like here – http://jlep.net/home/?page_id=324

Worth, it should be noted, in the following fashion – ‘VA CLE credits: The Virginia Bar Association approved this event for 5.5 credits.’ Admittedly, Prof. Tabbarok is not a securities lawyer, nor is he married to one, so it would unreasonable to him keep up with the sort of research that the Henry G. Manne Program in Law & Economics Studies undoubtedly remains dedicated to.


17 Ray Lopez April 19, 2017 at 8:38 am

I was going to say that indeed insider trading is a victimless crime, but it seems you beat me to it (if you are saying the same thing, indirectly).

As for The Answer to AlexT’s problem, it’s simply strengthening our patent laws to make them more patentee friendly. Right now the term of protection (life) for drug patents is so short, a mere 20 years from the date of filing, that drug companies have to apply for extensions based on FDA delays, which is tedious and not an automatic right. A better solution is to give all ‘pioneer patents’ an automatic 50 year life (as is the case with copyrights already, which are far less valuable) or even 100 years life, rather than 20 years.


18 Troll Me April 19, 2017 at 11:35 am

Insider trading is not victimless. It robs gains from non-crime-committing rest-of-the-world in the instance and puts them into the hands of criminals who appear to believe that “ability to take” is all they need to justify a theft.

I am not aware of sound economic arguments to promote capital accumulation in the hands of those with such tendencies.

Anyways, isn’t Congress able to do insider trading legally? Probably that’s much lower hanging fruit than increased enforcement where rules already apply.


19 Ray Lopez April 19, 2017 at 1:12 pm

“Insider trading is not victimless” – yes it is. If you are sleeping, and your camp-mate, the former member of Congress Anthony Weiner, pulls out his member and puts it next to your face on the pillow, but you are unaware of it, is that a crime if nobody is there to witness it, and assuming the pervert does not take a photo? In law school (that I dropped out of) they said no. So by the same analogy inside trading is victimless since the person who unwittingly sold their stock before the inside news outed did so voluntarily. I admit it’s maybe a moral crime from an inequality point of view (rich get richer), but I don’t see it as being a common law actual crime.


20 mulp April 19, 2017 at 1:55 pm

There were no victims in the failure of Theranos getting FDA approval for its products that don’t work as Holmes claimed. Just greedy people thinking the FDA is just a waste because the free market delivers revolutionary results cheaply and quickly.

21 Troll Me April 19, 2017 at 4:01 pm

I’m not debating whether it is criminal.

I’m debating whether it is victimless. If someone manipulates the market so that honest actors get less and dishonest actors get more, then by definition the honest people are being victimized.

Insider trading victimizes honest people, and pushes capital assets towards those with proven willingness to screw over people to pad their own pockets. Not good. The only way to pad your pockets should be to create value.

22 AlanG April 19, 2017 at 7:55 am

Alex writes “quite a few cases were FDA insiders trade on their information…” and then looking at the hyperlinks, he cites exactly two cases which were both in the generic drugs division (not a lot of money to be made on those bets). The third link is to the notorious ImClone case (paging Martha Stewart) that did not involve any FDA employees at all.

I don’t think two qualifies as “quite a few.” MR readers deserve much better than this!


23 Bill April 19, 2017 at 8:00 am

You are setting too high a bar to require Alex to provide sufficient evidence for his beliefs.


24 Jan April 19, 2017 at 8:47 am

Given the hundreds, sometimes thousands, of drugs that FDA reviews each year, including generics, Alex’s claim of “quite a few” is a bit laughable. Of course any insider trading is unacceptable. Just ask Tom Price, the man responsible for overseeing all of HHS, including FDA.


25 Alex Tabarrok April 19, 2017 at 9:13 am



26 The Other Jim April 19, 2017 at 9:20 am

Alex is a New York Times worshipper, so it’s not surprising to see him falling in line with their quality of reporting.

Although he did stray from the guidelines a bit – a true NYT “reporter” would have said “a disturbing number of cases.” That way, when a sane person pointed out that it was only 2 out of four thousand, they could retain plausibility, because all of them are disturbed individuals.


27 Jan April 19, 2017 at 8:04 am

1) Drug companies already address this problem by simply charging more for other products to make up the difference in projected revenue. Drug prices for new and older on patent drugs continue to outpace even health care inflation overall. It’s almost as if they are companies that will seek to maximize profit by charging prices as high as the market will pay, including Medicare.

2) High US prices are not linked to research costs, including FDA approval processes, as has been shown multiple times. http://healthaffairs.org/blog/2017/03/07/rd-costs-for-pharmaceutical-companies-do-not-explain-elevated-us-drug-prices/


28 The Other Jim April 19, 2017 at 11:56 am

We thank the deranged Jan for the pointless and irrelevant “study,” and also award him NYT style points for using the word “multiple” while citing only one thing. Very nice.

Anyway – if the question is why do pharma companies charge Americans more than other people, their given answer has never been “because our R+D costs are so high.” That makes zero sense on its face. It would be like asking Hillary why she pays her female staffers less than her male ones, and getting the reply “because my expenses are so high.”

The pharma company’s answer is, and always has been, “because it is illegal to charge other countries any more than we do.” Hillary, of course, has no answer.


29 Jan April 19, 2017 at 5:30 pm

Haha, their answer is ALWAYS because R&D costs are so high. Go to any of the dozens of events held on drug prices each year. They are consistent if nothing else.

As to a “study,” a peer reviewed journal may not hold a candle to Facebook lies that your Uncle Bill posts, but its a start. And yes there are other studies showing the same exact thing. Just google it. Americans pay so much money for drugs because we are stupid and accept what the drug industry lobby tells us to do. It’s pretty simple.


30 Thanatos Savehn April 19, 2017 at 10:22 am

Their business model has been to develop drugs that help the average patient, and thus to sell lots of drugs to no one in particular. But average is over (TM) and unless they stumble upon a new drug with a very large effect size they’re stuck trying to p-hack and HARK their way to the approval of drugs which improve average outcomes only very marginally over existing generics. The future of pharma is in bespoke drug regimens, immunotherapy and likely microflora modulation but since no one has figured out a way to achieve in such a future the sort of mass production with economies of scale needed to support the businesses as they existed a decade ago they’re very slowly being unwound. Pharma is having its own slo-mo Kodak moment.


31 Slugger April 19, 2017 at 10:48 am

If there were a betting market, my default bet would be to take the other side of any CEO statements about a new product. The greater the promises made by the CEO, the more money I’d put up. This is not Pharma specific.


32 mulp April 19, 2017 at 1:57 pm

IE, you bought a huge interest in Theranos?


33 Slugger April 19, 2017 at 2:47 pm

My default is to take the other side of the CEO’s statements. Fresno State plays Bama this fall; I expect a very positive statement by their coach.


34 Boonton April 19, 2017 at 10:53 am

I believe if studies produce bad data, companies may simply decide not to even apply for approval (or apply for additional indications if the drug is already approved). With these insurance policies what incentive would be created to waste time by pointlessly applying when it’s known the FDA would have no good reason to say yes?


35 Bill Walker April 19, 2017 at 12:25 pm

Actually there is plenty of low-hanging fruit. The problem is that there are no FDA approval categories for “anti-agathic”, or “nootropic”, etc. Telomerase activators, senolytics, etc. could extend and improve life… but there’s no way to apply for an approval to sell them. Look what happened to TA-65 and TAM-818.

Bezos is trying for senolytics with Unity, but he’ll end up having to sell them on Amazon. Oh wait, that might just work out.


36 Boonton April 19, 2017 at 1:20 pm

What exactly defines effectiveness with a life-extension therapy? Think about the criteria you would use in an effective clinical trial of such a therapy and assume the therapy really works. It seems like there would be a lot of indications you could try for approval on. For example, if you slowed aging you would also slow or prevent diseases that are associated with age (high BP, heart disease, diabetes, cancer, dementia, etc. etc.). It seems to me you could try to achieve an initial approval as a preventative therapy.


37 mulp April 19, 2017 at 2:01 pm

The private equity and NASDAQ already provide the insurance policies Alex says should be invented.

Why an economist fails to understand that the entire equity market and stock market is inherently risk insurance is a mystery. Didn’t Alex study economic history circa four to five centuries ago in Northern Europe?


38 Plucky April 20, 2017 at 10:05 am

The #1 problem with proposals like this to create standardized futures contract is that it is more driven by economists’ desire to have a price to observe than the potential for a well-functioning market.

In order to have a functioning futures market, there have to be natural hedgers on both the supply and demand size of a market. While it’s obvious why a drug company would a hedge market useful, it’s not obvious what drug buyers would get out of this market. The natural hedgers on the demand side would be health insurance co’s, but why would it be in their interests to hedge an FDA approval? An approved new drug is something they will have to purchase, but their entire business model is about passing that cost through to the policyholders. The only people who are genuine “natural shorts” are individual consumers, and retail hedging is usually unworkable. For a health insurer, a more sensible way to hedge would be fronting a portion of the cost for the trials in exchange for a pre-agreed, advantageous price on the drug if it got approved. That sort of thing would probably get state insurance regulators involved and be more hassle than it is worth for them.

Without demand-side hedgers to match up with supply side hedgers, you don’t really have the basis for a liquid, well-functioning market. Commodity futures markets work because both supply and demand-side hedgers use them, and the supply-demand gaps that speculators fill are small in comparison to the overall market. Markets with hedgers all on the supply side and speculators filling the gap on the demand side does not make for a good futures markets. Those sort of situations are better for insurance companies (general insurance companies I mean- MetLifes, not Humanas).


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