The Risk and Return of Venture Capital

41 Pages Posted: 3 Apr 2001  

John H. Cochrane

Hoover Institution; National Bureau of Economic Research (NBER); University of Chicago - Booth School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: January 4, 2001

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 firms 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 find a mean log return of about 100% and a log CAPM intercept of about 90%. With the selection bias correction, I find a mean log return of about 7% 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 find an arithmetic average return of around 700% and a CAPM alpha of nearly 500%. With the selection bias correction, I find arithmetic average returns of about 53% and CAPM alpha of about 45%.

Second, third, and fourth rounds of financing are less risky. They have progressively lower volatility, and therefore lower arithmetic average returns. The betas of successive rounds also decline dramatically from near 1 for the first 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.

Keywords: Venture capital, selection bias, risk and return

JEL Classification: G0

Suggested Citation

Cochrane, John H., The Risk and Return of Venture Capital (January 4, 2001). Available at SSRN: https://ssrn.com/abstract=253798 or http://dx.doi.org/10.2139/ssrn.253798

John H. Cochrane (Contact Author)

Hoover Institution ( email )

Stanford, CA 94305-6010
United States
6507236708 (Phone)

HOME PAGE: http://faculty.chicagobooth.edu/john.cochrane/index.htm

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-0458 (Fax)

HOME PAGE: http://faculty.chicagobooth.edu/john.cochrane/research/Papers/

Paper statistics

Downloads
3,462
Rank
1,813
Abstract Views
12,235