Optimal Allocation to Private Equity
66 Pages Posted: 4 Feb 2021 Last revised: 27 May 2021
Date Written: January 6, 2021
We study the asset allocation problem of an institutional investor (LP) that invests in stocks, bonds, and private equity (PE). PE investments are risky, illiquid, and long-term. The LP repeatedly commits capital to PE funds, and this capital is gradually called and eventually distributed back to the LP. We find that PE investments substantially affect the LP’s optimal allocations. LPs with higher and lower risk aversion follow qualitatively different investment strategies, and PE allocations are not monotonically declining in risk aversion. We extend the model with a secondary market for PE partnership interests to study the implications of trading in this market and the pricing of NAV and unfunded liabilities.
Keywords: Private Equity, Limited Partner, Asset Allocation, Portfolio Problem, Illiquidity, Secondary Market
JEL Classification: G11, G23, G24
Suggested Citation: Suggested Citation