How Much for a Haircut? Illiquidity, Secondary Markets, and the Value of Private Equity

58 Pages Posted: 22 May 2015 Last revised: 19 Mar 2016

See all articles by Nicolas P. B. Bollen

Nicolas P. B. Bollen

Vanderbilt University - Finance

Berk A. Sensoy

Vanderbilt University - Finance

Date Written: March 2, 2016

Abstract

Limited partners (LPs) of private equity funds commit to invest with extreme levels of illiquidity and significant uncertainty regarding the timing of capital flows. Secondary markets have emerged which alleviate some of the associated cost. This paper develops a subjective valuation model incorporating these institutional features. Model-implied breakeven returns are close to empirically observed average fund returns for moderately risk tolerant LPs with private equity allocations up to 40%. Likewise, optimal portfolio allocations for these LPs are similar to those observed in practice. More risk averse LPs optimally place little, but not zero, weight on private equity.

Keywords: private equity, performance, secondary market, liquidity, value, risk

JEL Classification: G11, G12 , G23, G24

Suggested Citation

Bollen, Nicolas P.B. and Sensoy, Berk A., How Much for a Haircut? Illiquidity, Secondary Markets, and the Value of Private Equity (March 2, 2016). Vanderbilt Owen Graduate School of Management Research Paper No. 2608549; Charles A. Dice Center Working Paper No. 2015-08; Fisher College of Business Working Paper No. 2015-03-08. Available at SSRN: https://ssrn.com/abstract=2608549 or http://dx.doi.org/10.2139/ssrn.2608549

Nicolas P.B. Bollen

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States

Berk A. Sensoy (Contact Author)

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States

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