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Optimal investment of private equity

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  • Liu, Yang
  • Yang, Jinqiang

Abstract

We investigate the implications of illiquidity and compensation structure on the investment decision of Private Equity (PE). We use a real option model to capture the optimal entry of PE investment for the risk-averse investors, and it shows that the illiquidity has ambiguous effects on the investment hurdle. Different from the economic implications of standard real option, our model shows that high illiquidity may accelerate or delay the investment decision. Management fees or carried interest will induce under-investment of PE. Moreover, our theoretical predictions are supported by the empirical evidence.

Suggested Citation

  • Liu, Yang & Yang, Jinqiang, 2015. "Optimal investment of private equity," Finance Research Letters, Elsevier, vol. 14(C), pages 76-86.
    • Handle: RePEc:eee:finlet:v:14:y:2015:i:c:p:76-86
    DOI: 10.1016/j.frl.2015.05.013
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    Cited by:

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    2. Bian, Yuxiang & Chen, Lin & Xiong, Xiong & Yang, Jinqiang, 2023. "Private equity valuation under time-inconsistent preferences," Research in International Business and Finance, Elsevier, vol. 65(C).
    3. Xu, Qing & Yang, Jinqiang, 2017. "Real option with liquidity constraints under secondary debt illiquidity risk market," Finance Research Letters, Elsevier, vol. 21(C), pages 57-65.
    4. Cole, Rebel & Cumming, Douglas & Li, Dan, 2016. "Do banks or VCs spur small firm growth?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 41(C), pages 60-72.
    5. Cumming, Douglas & Zhang, Yelin, 2016. "Alternative investments in emerging markets: A review and new trends," Emerging Markets Review, Elsevier, vol. 29(C), pages 1-23.

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    More about this item

    Keywords

    Real option; Private equity; Illiquidity; Compensation structure;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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