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

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

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.

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Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

Volume (Year): 47 (2012)
Issue (Month): 03 (August)
Pages: 511-535

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Handle: RePEc:cup:jfinqa:v:47:y:2012:i:03:p:511-535_00
Contact details of provider: Postal: Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK
Web page: http://journals.cambridge.org/jid_JFQ
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  1. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2004. "The Cross-Section of Volatility and Expected Returns," NBER Working Papers 10852, National Bureau of Economic Research, Inc.
  2. John H. Cochrane, 2001. "The Risk and Return of Venture Capital," NBER Working Papers 8066, National Bureau of Economic Research, Inc.
  3. Andrew Metrick, 2010. "The Economics of Private Equity Funds," Review of Financial Studies, Society for Financial Studies, vol. 23(6), pages 2303-2341, June.
  4. 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.
  5. 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.
  6. Jerry Cao & Josh Lerner, 2006. "The Performance of Reverse Leveraged Buyouts," NBER Working Papers 12626, National Bureau of Economic Research, Inc.
  7. Michael Ewens & Charles Jones & Matthew Rhodes-Kropf, . "The Price of Diversifiable Risk in Venture Capital and Private Equity," GSIA Working Papers 2012-E55, Carnegie Mellon University, Tepper School of Business.
  8. 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, 08.
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