Features and Determinants of Risk in Investment Choices by Private Equity Funds
28 Pages Posted: 28 Jul 2016 Last revised: 17 Oct 2017
Date Written: October 2017
In this paper, we propose a measure of riskiness of PE assets alternative to the CAPM derived beta coefficient usually suggested in the literature on performance of PE Funds. We assume that at any given point in time there exist alternative investment opportunities that may be classified into a limited number of types, and that Funds look at the risk/return profile of each of the available investment types when taking their investment decisions. We first estimate a discrete choice model of the Fund Managers’ investment decisions by type of PE investment, as a function of the observed characteristics of the Fund, of the Deal and of the Portfolio Company, as well as of the expected returns and expected loss of the PE deals. Given the chosen type of investment, we then estimate the probability of negative returns of each deal in each investment class. These predicted probabilities together with the historical expected shortfalls by investment type, yield the Expected Loss by deal, the measure of pure risk we propose in this paper. We find that it is possible to identify the idiosyncratic features of each investment type and that the patterns and degrees of riskiness differ quite significantly among them.
Suggested Citation: Suggested Citation