Risk Adjustment of Private Equity Cash Flows

51 Pages Posted: 7 Feb 2022

See all articles by Nicola Giommetti

Nicola Giommetti

Copenhagen Business School - Department of Finance

Rasmus Jørgensen

Copenhagen Business School - Department of Finance; ATP

Date Written: December 7, 2021

Abstract

Existing stochastic discount factor methods for the valuation of private equity funds result in unrealistic time discounting. We propose and evaluate a modified method. Valuation has a risk neutral component plus a risk adjustment, and we fix the risk-neutral component by constraining the subjective term structure of interest rates with market data. We show that (i) our approach allows for economically meaningful measurement and comparison of risk across models, (ii) existing methods estimate implausible performance when time discounting is particularly degenerate, and (iii) our approach results in lower variation of performance across funds.

Keywords: Private Equity, Valuation, Risk Adjustment, Stochastic Discount Factor, CAPM, Long-Term Investor

Suggested Citation

Giommetti, Nicola and Jørgensen, Rasmus, Risk Adjustment of Private Equity Cash Flows (December 7, 2021). Available at SSRN: https://ssrn.com/abstract=3980121 or http://dx.doi.org/10.2139/ssrn.3980121

Nicola Giommetti (Contact Author)

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, 2000
Denmark

Rasmus Jørgensen

Copenhagen Business School - Department of Finance

Solbjerg Plads 3, SOL/A4.17
Copenhagen, Frederiksberg 2000

ATP

Kongens Vænge 8
DK-3400 Hillerød
Denmark

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