Venture Capital and Private Equity Diversification: A Var and DCC Garch Approach

Abstract

The terms “venture capital” and “private equity” are used in a loosely interchangeable manner when capital is invested in innovative technology-driven ideas or nascent-stage/unlisted companies. Pre-revenue idea-based/nascent-stage unlisted start-ups are financed by investors classified as venture capitalist investments, whereas post-revenue established unlisted companies are financed by private equity investors. Institutional investors fund venture capitalists and private equity investors separately since they are considered two different types of investments. The purpose of this paper is to determine whether the returns of nascent-stage start-ups (Venture Capital Index) exhibit a causal effect and transmit volatility onto the returns of the more established post-revenue-stage unlisted companies (Private Equity Index) and vice-versa. The study used vector auto regression and DCC GARCH to understand this relationship. The findings showed that the returns
of nascent-stage start-up venture capital index unidirectionally trigger the growth of returns of the more established private unlisted companies’ index, and lead to volatility transmission from venture capital index to private equity index that persists over a long period of time. Also, immediate shocks transmitted from the VCI index to PEI don’t impact volatility in the short term. Institutional investors will be informed that the Venture Capital Index not only triggers the returns of the Private Equity Index, but also transmits the volatility spill over to the Private Equity Index, an effect that persists over a longer duration of time, thereby making the Private Equity Index vulnerable to the volatility of the Venture Capital Index.