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

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...

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Bibliographic Details
Published in:Journal of financial and quantitative analysis 2012-06, Vol.47 (3), p.511-535
Main Authors: Driessen, Joost, Lin, Tse-Chun, Phalippou, Ludovic
Format: Article
Language:English
Subjects:
Assets
Capital costs
Cash flow
Dividends
Economic dynamics
Equity
Fees
Financial investments
Inactive
Internal rate of return
Investment risk
Investors
Methodology
Private equity
Quantitative analysis
Simulation
Venture capital
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Summary: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.
ISSN:0022-1090
1756-6916
DOI:10.1017/S0022109012000221