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

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  • Driessen, Joost
  • Lin, Tse-Chun
  • Phalippou, Ludovic

Abstract

We develop a new methodology to estimate abnormal performance and risk exposure of nontraded assets from cash flows. Our methodology extends the standard internal rate of return approach to a dynamic setting. The small-sample properties are validated using a simulation study. We apply the method to a sample of 958 private equity funds. For venture capital funds, we find a high market beta and underperformance before and after fees. For buyout funds, we find a relatively low market beta and no evidence for outperformance. We find that self-reported net asset values significantly overstate fund values for mature and inactive funds.

Suggested Citation

  • 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(3), pages 511-535, June.
  • Handle: RePEc:cup:jfinqa:v:47:y:2012:i:03:p:511-535_00
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    References listed on IDEAS

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    1. Cao, Jerry & Lerner, Josh, 2009. "The performance of reverse leveraged buyouts," Journal of Financial Economics, Elsevier, vol. 91(2), pages 139-157, February.
    2. Steven N. Kaplan & Antoinette Schoar, 2005. "Private Equity Performance: Returns, Persistence, and Capital Flows," Journal of Finance, American Finance Association, vol. 60(4), pages 1791-1823, August.
    3. Cochrane, John H., 2005. "The risk and return of venture capital," Journal of Financial Economics, Elsevier, vol. 75(1), pages 3-52, January.
    4. Michael Ewens & Charles M. Jones & Matthew Rhodes-Kropf, 2013. "The Price of Diversifiable Risk in Venture Capital and Private Equity," Review of Financial Studies, Society for Financial Studies, vol. 26(8), pages 1854-1889.
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    6. Gompers, Paul & Lerner, Josh, 2000. "Money chasing deals? The impact of fund inflows on private equity valuation," Journal of Financial Economics, Elsevier, vol. 55(2), pages 281-325, February.
    7. Axelson, Ulf & Strömberg, Per Johan & Weisbach, Michael, 2007. "Why are Buyouts Leveraged? The Financial Structure of Private Equity Firms," CEPR Discussion Papers 6133, C.E.P.R. Discussion Papers.
    8. Andrew Metrick, 2010. "The Economics of Private Equity Funds," Review of Financial Studies, Society for Financial Studies, vol. 23(6), pages 2303-2341, June.
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    More about this item

    JEL classification:

    • 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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