Measuring Risk for Venture Capital

Risk can be measured for venture capital and for all other assets organized as limited partnerships. Because of the conventions that general partners use to report value each quarter (or for hedge funds, each month), the methods are a bit more complicated than the simple regressions used to measure beta for traded securities and portfolios.

Essentially, the accounting conventions of general partners smooth their reported returns, and it is necessary to econometrically un-smooth them to measure risk and performance. The good news is that it is feasible. The bad news is that you need a longer span of time in order to measure at all. Because return is reported each quarter, you need five years of returns to get 20 observations, and this is the minimum that is informative. But don’t give up hope, as long as you have enough observations, they are very informative.

For hedge funds, who typically report return each month, two years of data is sufficient. If the strategy of the fund is sufficiently stable, even 18 months of returns can be informative.

For details, have a look at our paper on Measuring Risk for Venture Capital and Buyouts. This generalizes to all other assets organized as limited partnerships, including real estate, oil & gas, mezzanine debt, distressed debt, hedge funds, and other special situations involving financial instruments that are intermittently priced.



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