Working Paper: NBER ID: w19347
Authors: Arthur Korteweg; Stefan Nagel
Abstract: Performance evaluation of venture-capital (VC) payoffs is challenging because payoffs are infrequent, skewed, realized over endogenously varying time horizons, and cross- sectionally dependent. We show that standard stochastic discount factor (SDF) methods can be adapted to handle these issues. Our approach generalizes the Public Market Equivalent (PME) measure commonly used in the private-equity literature. We find that the abnormal returns from both VC funds and VC start-up investments are robust to relaxing the strong distributional assumptions and implicit SDF restrictions from the prior literature: VC start-up investments earn substantial positive abnormal returns, and VC fund abnormal returns are close to zero. We further show that the systematic component of start-up company and VC fund payoffs resembles the negatively skewed payoffs from selling index put options, which contrasts with the call option-like positive skewness of the idiosyncratic payoffs. Motivated by this finding, we explore an SDF that includes index put option returns. This results in negative abnormal returns to VC funds, while the abnormal returns to start-up investments remain large and positive.
Keywords: venture capital; risk adjustment; stochastic discount factor; public market equivalent
JEL Codes: G12; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| SDF approach (C69) | GPME measure (C52) |
| systematic component of VC payoffs (G11) | negatively skewed payoffs from selling index put options (G13) |
| skewness of VC payoffs (C46) | challenge common perception of VC investments as call option-like (G24) |
| short put option characteristics (G13) | emerge in analysis of VC investments (G24) |
| VC startup investments (G24) | positive abnormal returns (G12) |
| VC fund returns (G24) | close to zero (C60) |
| SDF incorporating index put option returns (C69) | negative abnormal returns for VC funds (G24) |
| SDF incorporating index put option returns (C69) | large positive abnormal returns for startup investments (G24) |