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Private Equity Performance and Liquidity Risk

Author

Listed:
  • Francesco FRANZONI

    (University of Lugano and Swiss Finance Institute)

  • Eric NOWAK

    (University of Lugano and Swiss Finance Institute)

  • Ludovic PHALIPPOU

    (University of Amsterdam Business School)

Abstract

This is the first study that provides evidence of liquidity risk in a large sample of private equity investments. It relies on the realized cash flows of 4,403 liquidated in- vestments. We find that a one standard deviation increase in unexpected aggregate liquidity raises returns between 4% and 10% annually, depending on liquidity measures. This effect is robust to controlling for investment characteristics and macroeconomic variables. Larger investments and investments from more mature private equity firms have returns that are more sensitive to unexpected liquidity. Using the Pástor and Stambaugh (2003) traded liquidity factor, we estimate a liquidity risk premium in pri- vate equity of about 3% annually. Accounting for liquidity risk, the historical cost of capital for private equity is about 24% annually and the alpha (before fees) is close to zero.

Suggested Citation

  • Francesco FRANZONI & Eric NOWAK & Ludovic PHALIPPOU, 2009. "Private Equity Performance and Liquidity Risk," Swiss Finance Institute Research Paper Series 09-43, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0943
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    Citations

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    Cited by:

    1. Lin, Hai & Wang, Junbo & Wu, Chunchi, 2011. "Liquidity risk and expected corporate bond returns," Journal of Financial Economics, Elsevier, vol. 99(3), pages 628-650, March.
    2. Braun, Reiner & Engel, Nico & Hieber, Peter & Zagst, Rudi, 2011. "The risk appetite of private equity sponsors," Journal of Empirical Finance, Elsevier, vol. 18(5), pages 815-832.

    More about this item

    Keywords

    Private equity; Liquidity risk; Cost of capital;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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