The Risk and Return of Venture Capital

John Cochrane

University of California at Los Angeles, Anderson Graduate School of Management from Anderson Graduate School of Management, UCLA

Abstract: This paper measures the mean, standard deviation, alpha and beta of venture capital investments, using a maximum likelihood estimate that corrects for selection bias. Since Þrms go public when they have achieved a good return, estimates that do not correct for selection bias are optimistic. The selection bias correction neatly accounts for log returns. Without a selection bias correction, I Þnd a mean log return of about 100% and a log CAPM intercept of about 90%. With the selection bias correction, I Þnd a mean log return of about 5% with a -2% intercept. However, returns are very volatile, with standard deviation near 100%. Therefore, arithmetic average returns and intercepts are much higher than geometric averages. The selection bias correction attenuates but does not eliminate high arithmetic average returns. Without a selection bias correction, I Þnd an arith- metic average return of around 700% and a CAPM alpha of nearly 500%. With the selection bias correction, I Þnd arithmetic average returns of about 57% and CAPM alpha of about 45%. Second, third, and fourth rounds of Þnancing are less risky. They have progres- sively lower volatility, and therefore lower arithmetic average returns. The betas of successive rounds also decline dramatically from near 1 for the Þrst round to near zero for fourth rounds. The maximum likelihood estimate matches many features of the data, in particular the pattern of IPO and exit as a function of project age, and the fact that return distributions are stable across horizons.

Date: 2000-01-04
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Related works:
Journal Article: The risk and return of venture capital (2005)
Working Paper: The Risk and Return of Venture Capital (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:cdl:anderf:qt7qm9h594

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