Sunday, September 09, 2012

Cone of uncertainty in Financial and Patent Portfolios.

The picture above is a screenshot from a lecture on Financial Theory. It shows how one can hedge his bets when facing uncertainty and risk. In the example on the board, the professor shows how to win a favorable large bet by making a series of small side bets using backward induction.
Since the future is uncertain, he builds a tree of possible futures, with certain probabilities assigned to each branch of the tree. In theory the tree is infinite, but in reality its internal branches lead to equivalent results (recombining tree); therefore, we can consider the whole tree growing inside a limited cone of uncertainty.
Below is a slide from one of my Stanford lectures on the relationship between innovation strategy and patent portfolio. It also shows a cone of high-tech business uncertainty. The cone covers technology development options, which tend to move sideways (yellow spot) as the world develops. If you target your patent portfolio toward the "bull's eye" of today's implementation, you portfolio is likely to be of low value in the future. Therefore, you have to hedge your bets with patents that cover the entire cone.

1. Similar to a hedged financial portfolio, the innovator would be better off by building a patent portfolio using backward induction rather than patenting today's implementations.

2. The difference between financial and patent portfolio hedging would be in the timing aspect. That is, because with patents priority dates are of paramount importance, the innovator has to hedge by a) inventing the whole tree (within the cone); b) trimming the patent tree to reality as the time progresses, by divesting from the earlier patent assets.

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