NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Risk and Return of Venture Capital

John H. Cochrane

NBER Working Paper No. 8066
Issued in January 2001
NBER Program(s):   AP

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.

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Document Object Identifier (DOI): 10.3386/w8066

Published: Cochrane, John H. "The Risk And Return Of Venture Capital," Journal of Financial Economics, 2005, v75(1,Jan), 3-52.

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