The Intertemporal Risk-Return Relation is Alive and Well, It's Interpretation? Not So Much

Abstract

Using data from 1980 through 2005, and implementations of the Intertemporal Capital Asset Pricing Model (ICAPM), this study consistently generates positive intertemporal risk-return relations within venture capital markets. During the first five years of business, venture capitalists (VCs) are shown to be risk averse, and are characterized by a Coefficient of Relative Risk Aversion (CRRA) estimated at about 2.75. From the sixth year of business onwards, VCs are characterized by CRRAs that are no higher than 1.91. Combination of rigorous theoretical and empirical evidence establishes that CRRAs less than or equal to 2.00 are evidence for risk seeking preferences. The CRRA for the representative risk bearing agent who aggregates preferences of risk averse and risk seeking agents is shown to aggregate to 3.59. This outcome, to wit, a higher CRRA (3.59) for an agent who aggregates risk averse and risk seeking preferences, in relation to the CRRA for the embedded representative risk averse agent (2.75) is formally and theoretically shown to be outcome that subsists in equilibrium. Totality of the formal theoretical and empirical evidence demonstrates interpretations of CRRAs that are higher than 2.75 as evidence for stock markets that consist in entirety of risk averse agents is not robust.

Keywords: Venture Capital, Skewness, Price of Risk, ICAPM, Coefficient of Relative Risk Aversion, Risk Premiums

JEL Classification: G24, G11