A Model to Measure Portfolio Risks in Venture Capital

Abstract:     
This study constructs and evaluates a risk model for the venture capital industry in which the CreditRisk+ model is adjusted to calculate loss distributions for venture capital portfolios. A forward entry regression with macroeconomic factors as independent variables is used as the procedure to extract systematic factors for the sector analysis. The coefficient of determination R² divides the risk into one idiosyncratic risk factor and several systematic risk factors. Under the assumption that macroeconomic factors are independent, the improvement of the R² of each forward entry is considered as the weight of the entered factor. Further, under the assumption that all relevant systematic risk factors are incorporated in the model, the systematic risk is entirely explained. The remaining unexplained sample variance is considered the idiosyncratic risk.

The introduced risk model is empirically tested using a portfolio of venture capital financed companies. The database contains more than 2,000 European venture capital-backed companies over the period 1998-2004. The results are highly significant and show that the model is applicable to modelling portfolio risks for venture capital portfolios.

Number of Pages in PDF File: 28

Keywords: Private Equity, Venture Capital, Credit Risk, Model Construction, Model Evaluation, Portfolio Choice, Investment Policy

JEL Classification: G11, G31, C51, C52

working papers series