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The Price of Diversifiable Risk in Venture Capital and Private Equity

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  • Michael Ewens
  • Charles Jones
  • Matthew Rhodes-Kropf

Abstract

This paper explores the venture capital (VC) market and extends the standard principal-agent problem between the investor and venture capitalist to show how it alters the interaction between the venture capitalist and the entrepreneur. The nature of the three way interaction results in a correlation between total risk and investor net of fee returns. Thus, we show how and why diversifiable risk should be priced in VC deals even though investors are fully diversified. We then take our theory to a unique data set and show that there is a strong correlation between realized risk and investor returns, as predicted by the theory.

Suggested Citation

  • Michael Ewens & Charles Jones & Matthew Rhodes-Kropf, "undated". "The Price of Diversifiable Risk in Venture Capital and Private Equity," GSIA Working Papers 2012-E55, Carnegie Mellon University, Tepper School of Business.
  • Handle: RePEc:cmu:gsiawp:-234463881
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    1. Michael Ewens & Matthew Rhodes-Kropf, 2015. "Is a VC Partnership Greater Than the Sum of Its Partners?," Journal of Finance, American Finance Association, vol. 70(3), pages 1081-1113, June.
    2. Lo, Andrew W. & Craig MacKinlay, A., 1990. "An econometric analysis of nonsynchronous trading," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 181-211.
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