Health and the Option Value of Medical Innovation

Abstract

We propose a dynamic framework to study the option value of medical innovation, which accrues - in expectation - to healthy individuals who anticipate some possibility of future illness. We apply our framework to evaluate an HIV treatment breakthrough known as HAART. In lowering both the expected cost and likelihood of HIV infection, HAART reduced the implicit price of risky sex. Forward-looking agents responded by optimally shifting their behavior. The magnitude of their responses permits identification of health state dependent utility parameters, from which we can derive the the option value of medical innovation. The model also imposes equilibrium constraints, explicitly capturing how optimal shifts in behavior affect equilibrium choices by changing both infection probabilities and the ease of finding partners willing to engage in risky sex. Using the estimated model, we find that the option value of HAART introduction for healthy, uninfected agents corresponds to approximately 6 years of life.