Volatility and Venture Capital

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.