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.