Chasing the Deal with the Money: Measuring the Required Risk Premium and Expected Abnormal Returns of Private Equity Funds to Maximize Their Internal Rate of Return

Risk Governance & Control: Financial Markets & Institutions, Vol. 3, No. 3, 2013

14 Pages Posted: 1 Dec 2013 Last revised: 15 Dec 2013

See all articles by Fernando Scarpati

Fernando Scarpati

University of Roehampton - Social Sciences

Wilson Ng

IDRAC Business School, Campus de Lyon

Date Written: November 29, 2013

Abstract

A number of scholars of private equity (“PE”) have sought to assess the performance of PE firms by adopting an ex-post perspective of asset pricing. In doing so a set of phenomena has been recognized that is thought to be specific to the PE sector. However, by continuing to draw on an ex-post perspective few scholars have considered the possible extent to which PE phenomena may affect expected returns from investments. To address this issue this article draws on an ex-ante perspective of investment decision-making in suggesting how a number of drivers and factors of PE phenomena may produce “abnormal returns”, and that each of those drivers and factors should therefore be considered in accurately assessing the required risk premium and expected abnormal returns of PE investments. Based on research of a PE investment and a telephone questionnaire to 40 PE firms in the EU the article suggests principally that while size is the most important driver in producing abnormal returns, illiquidity alone cannot explain the expected returns of PE investments. A predictive model of PE decision-making was then developed that draws on an ex-ante perspective of asset pricing and takes into account PE phenomena and abnormal returns.

Keywords: Private equity funds, abnormal returns, Jensen's alpha, risk, risk-premium, drivers

JEL Classification: O16

Suggested Citation

Scarpati, Fernando and Ng, Wilson, Chasing the Deal with the Money: Measuring the Required Risk Premium and Expected Abnormal Returns of Private Equity Funds to Maximize Their Internal Rate of Return (November 29, 2013). Risk Governance & Control: Financial Markets & Institutions, Vol. 3, No. 3, 2013, Available at SSRN: https://ssrn.com/abstract=2361500

Fernando Scarpati (Contact Author)

University of Roehampton - Social Sciences ( email )

United Kingdom

Wilson Ng

IDRAC Business School, Campus de Lyon ( email )

47, Rue du Sergent Michel Berthet
Lyon, 69009
France
+447557098046 (Phone)
+6042292437 (Fax)

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