Valuing Private Equity Investments Strip by Strip
129 Pages Posted: 18 Oct 2019 Last revised: 29 Jan 2021
Date Written: December 16, 2020
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: Suggested Citation