Can Aversion to Variance Risk be Evidence of Risk Seeking Preferences? Evidence from Returns to VC Backed IPOs

Abstract

In this paper, we examine how venture capital portfolios with risk averse and risk seeking return characteristics are priced by the representative investor in public equity markets. We find only portfolios with risk seeking return characteristics are associated with a market skewness premium. Also, while the representative investor's aversion to variance risk and skewness preference are positively correlated in the pricing of portfolios with risk seeking return characteristics, they are negatively correlated in the pricing of portfolios with risk averse return characteristics. Our findings (a) show skewness preference is evidence of risk seeking behavior or preferences, and as such is inconsistent with globally concave utility functions; (b) indicate portfolio diversification (aversion to variance risk) can be evidence of risk averse or risk seeking preferences; and (c) establish empirically testable conditions for distinguishing between risk averse and risk seeking preferences.

Keywords: Venture Capital, Skewness, CAPM, Asset Pricing, Risk, Return, Capital

JEL Classification: G24, G11