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Deciphering The Economics Of Venture Capital

Black swan events were introduced by Nassim Nicholas Taleb in his 2001 book Fooled By Randomness, which concerned financial events. He outlined three characteristics of a black swan event:


  1. The event has a huge impact
  2. The event is very hard to explain using (commonly used) scientific methods
  3. The event appears unforeseen due to people’s psychological biases

The black swan events are popular in venture capital, a unique asset class that historically has all three characteristics as Taleb outlined, TechCrunch recently stated. What makes venture capital different from other asset classes is its complex qualitative and quantitative characteristics. The qualitative attributes are widely covered. The quantitative characteristics, not so much. TechCrunch shows a graphic regarding the distribution of returns in venture capital:


Moreover, on the way of avoiding decision errors in order to certainly improve returns, there are a number of errors generally committed in venture capital such as anchoring, availability bias, recency, unit bias  —  accepting valuations as “universal,” group thinking (bandwagon effect) — following the herd, cognitive inertia  — unwillingness to change thought patterns, irrational escalation  — re-upping investment even though one knows it’s a bad one, and overconfidence that will affect the returns. The graphic shows as follows, 


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