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A New Method to Estimate Risk and Return of Non-Traded Assets from Cash Flows: The Case of Private Equity Funds

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  • Joost Driessen
  • Tse-Chun Lin
  • Ludovic Phalippou

Abstract

We develop a new GMM-style methodology with good small-sample properties to assess the abnormal performance and risk exposure of a non-traded asset from a cross-section of cash flow data. We apply this method to a sample of 958 mature private equity funds spanning 24 years. Our methodology uses actual cash flow data and not intermediary self-reported Net Asset Values. In addition, it does not require a distributional assumption for returns. For venture capital funds, we find a high market beta and significant under-performance. For buyout funds, we find a low beta and no abnormal performance, but the sample is small. Larger funds have higher returns due to higher risk exposures and not higher alphas. We also find that Net Asset Values significantly overstate fund market values for the subset of mature and inactive funds.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14144.

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Date of creation: Jun 2008
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Publication status: published as Driessen, Joost & Lin, Tse-Chun & Phalippou, Ludovic, 2012. "A New Method to Estimate Risk and Return of Nontraded Assets from Cash Flows: The Case of Private Equity Funds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(03), pages 511-535, June.
Handle: RePEc:nbr:nberwo:14144

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  1. Jerry Cao & Josh Lerner, 2006. "The Performance of Reverse Leveraged Buyouts," NBER Working Papers 12626, National Bureau of Economic Research, Inc.
  2. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross-Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 61(1), pages 259-299, 02.
  3. Steven N. Kaplan & Antoinette Schoar, 2005. "Private Equity Performance: Returns, Persistence, and Capital Flows," Journal of Finance, American Finance Association, American Finance Association, vol. 60(4), pages 1791-1823, 08.
  4. Cochrane, John, 2000. "The Risk and Return of Venture Capital," University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA qt7qm9h594, Anderson Graduate School of Management, UCLA.
  5. Axelson, Ulf & Strömberg, Per Johan & Weisbach, Michael, 2007. "Why are Buyouts Leveraged? The Financial Structure of Private Equity Firms," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6133, C.E.P.R. Discussion Papers.
  6. Ayako Yasuda & Andrew Metrick, 2007. "The economics of private equity funds," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Oct.
  7. Gompers, Paul & Lerner, Josh, 2000. "Money chasing deals? The impact of fund inflows on private equity valuation," Journal of Financial Economics, Elsevier, Elsevier, vol. 55(2), pages 281-325, February.
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Cited by:
  1. Valkama, Petri & Maula, Markku & Nikoskelainen, Erkki & Wright, Mike, 2013. "Drivers of holding period firm-level returns in private equity-backed buyouts," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(7), pages 2378-2391.
  2. Ludovic Phalippou, 2009. "Beware of Venturing into Private Equity," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 23(1), pages 147-66, Winter.
  3. Marco Da Rin & Thomas F. Hellmann & Manju Puri, 2011. "A survey of venture capital research," NBER Working Papers 17523, National Bureau of Economic Research, Inc.
  4. Korteweg, Arthur & Nagel, Stefan, 2013. "Risk-Adjusting the Returns to Venture Capital," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9610, C.E.P.R. Discussion Papers.
  5. David T. Robinson & Berk A. Sensoy, 2012. "Do Private Equity Managers Earn Their Fees? Compensation, Ownership, and Cash Flow Performance," NBER Working Papers 17942, National Bureau of Economic Research, Inc.
  6. Kroencke, Tim A. & Muehler, Grit & Sprietsma, Maresa, 2013. "Return and risk of human capital contracts," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 13-108, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  7. David T. Robinson & Berk A. Sensoy, 2011. "Cyclicality, Performance Measurement, and Cash Flow Liquidity in Private Equity," NBER Working Papers 17428, National Bureau of Economic Research, Inc.

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