Volatility and Venture Capital

Ryan Peters, Finance, The Wharton School

Abstract: The performance of venture capital (VC) investments load positively on shocks to aggregate return volatility. I document this novel source of risk at the asset-class, fund, and portfolio-company levels. The positive relation between VC performance and volatility is driven by the option-like structure of VC investments, especially by VCs’ contractual option to reinvest. At the asset-class level, shocks to aggregate volatility explain a substantial fraction of VC returns. At the fund level, consistent with the reinvestment channel, this exposure is concentrated in years two through four of fund life and in early-stage VC funds, which have more embedded reinvestment options. For VC-backed portfolio companies, volatility shocks correlate with faster and more frequent reinvestment. The level of volatility at the time of investment has no relation with future performance, consistent with competitive markets. Overall, my results imply that the option-like features of VC investments are first-order determinants of risk in VC.

Read the full working paper here (PDF).

Michelle Eckert is Marketing and Communications Coordinator for the Mack Institute, where she works to engage students, researchers, and corporate partners in opportunities for collaboration. Michelle received her B.A. in Art from Valparaiso University in 2007. Her background includes two AmeriCorps terms of service working to teach mathematics, computer literacy, and job readiness skills to out-of-school youth in Philadelphia, focusing particularly on promoting access to post-secondary education.