Valuing Private Equity Investments Strip by Strip

129 Pages Posted: 18 Oct 2019 Last revised: 29 Jan 2021

See all articles by Arpit Gupta

Arpit Gupta

NYU Stern School of Business

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); ABFER

Date Written: December 16, 2020

Abstract

We propose a new valuation method for private equity investments. It first constructs a cash-flow replicating portfolio using cash-flows on various listed equity and fixed income instruments (strips). It then values the listed strips using a flexible asset pricing model that accurately captures the systematic risk in bonds of different maturities and a broad cross-section of equity factors. The method delivers a risk-adjusted profit on each PE investment and a time series for the expected return on each PE fund category. It avoids using realized discount rates and has good small-sample properties. We apply the method to the universe of PE funds. Under our more comprehensive risk model, we find negative risk-adjusted profits for the average fund in most PE categories. Substantial cross-sectional variation and persistence in performance suggests some funds outperform. Expected returns and risk-adjusted profit decline in the later part of the sample.

Keywords: private equity, cross-section, term structure of risk

JEL Classification: G24, G12

Suggested Citation

Gupta, Arpit and Van Nieuwerburgh, Stijn, Valuing Private Equity Investments Strip by Strip (December 16, 2020). Journal of Finance, Forthcoming, NYU Stern School of Business, Available at SSRN: https://ssrn.com/abstract=3466853 or http://dx.doi.org/10.2139/ssrn.3466853

Arpit Gupta (Contact Author)

NYU Stern School of Business ( email )

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HOME PAGE: http://arpitgupta.info

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business ( email )

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United States

HOME PAGE: http://https://www0.gsb.columbia.edu/faculty/svannieuwerburgh/

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Centre for Economic Policy Research (CEPR)

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