Special Properties of Private Equity in the Context of Portfolio Optimization

Fürstenberger, Mattias Thomas
May 2011
University of St. Gallen, Business Dissertations;5/13/2011, p1
The following study develops a continuous time model evaluating the return loss from the delayed investment flow into Private Equity investments. Using several assumptions, an optimal rule to invest the committed but not invested capital can be derived analytically. The model context is extended to diversified portfolios consisting of Private Equity, stocks and risk-free bonds and an optimal investment rule is derived over time. The fund flow into a Private Equity investment over time depends on the availability of investment opportunities. As a result, an investor cannot invest the entire commitment initially. The delayed investment flow results in a loss on the overall expected return of the Private Equity investment. If an investor cannot meet a capital call, he commits a default on commitment which is associated to a high penalty. The model derived throughout the analysis evaluates the opportunity cost from delayed investment and develops an optimal investment rule, taking the probability of a default on commitment into account. Extending the model setting to a diversified portfolio of Private Equity, public equity and risk-free bonds shows that the shortfall probability is close to zero for weights of Private Equity smaller than 50% for reasonable parameter values. As a result, the analytically derived optimal weights hold for those portfolios and the return loss can be reduced to a large extent. In a second step, a continuous time model is derived and solved taking the specific characteristics of Private Equity funds into account. This results in optimization rules that are considerably different from standard cases. Most important is the fact that risky assets are massively overweighted especially concerning public equity if the investment delay is not taken into account. Also Private Equity adds additional risk to the portfolio consistent with the risk aversion of the investor. The results are very sensitive to the correlation structure. For higher levels of correlation Private Equity provides a good diversification instrument to public equity and in case of no correlation it is a perfect substitute for risk-free bonds.


Related Articles

  • Decomposition of Optimal Portfolio Weight in a Jump-Diffusion Model and Its Applications. Jin, Xing; Zhang, Allen X. // Review of Financial Studies;Sep2012, Vol. 25 Issue 9, p2877 

    This article solves the portfolio choice problem in a multi-asset jump-diffusion model. We decompose the optimal portfolio weight into components that correspond to a collection of fictitious economies, one of which is a standard diffusion economy, and the others of which are pure-jump...

  • Counting the cost.  // Money Marketing;10/27/2011, p42 

    The author discusses the diversification and strategic asset allocation of the retail distribution review (RDR) via a multi-asset and low-cost investment method.

  • Portfolio Choice in Markets with Contagion. AÏT-SAHALIA, YACINE; HURD, Thomas Robert // Journal of Financial Econometrics;Winter2015, Vol. 14 Issue 1, p1 

    We consider the problem of optimal investment and consumption in a class of multidimensional jump-diffusion models in which asset prices are subject to mutually exciting jump processes. This captures a type of contagion where each downward jump in an asset's price results in increased likelihood...

  • WATADA'S FUZZY PORTFOLIO SELECTION MODEL AND ITS APPLICATION. INAN, GULTAC EROGLU; APAYDIN, AYSEN // Communications Series A1 Mathematics & Statistics;2013, Vol. 62 Issue 2, p17 

    Portfolio selection has been originally proposed by H.M. Markowitz 1952. The Markowitz's approcach to the portfolio selection has some difficulties. For example, an aspiration level given by decision makers aren't taken into consideration in the Markowitz approach. In this paper, Watada's Fuzzy...

  • Mean-risk model for uncertain portfolio selection. Xiaoxia Huang // Fuzzy Optimization & Decision Making;Mar2011, Vol. 10 Issue 1, p71 

    This paper discusses the uncertain portfolio selection problem when security returns cannot be well reflected by historical data. It is proposed that uncertain variable should be used to reflect the experts' subjective estimation of security returns. Regarding the security returns as uncertain...

  • An efficient DC programming approach for portfolio decision with higher moments. Pham Dinh, Tao; Niu, Yi-Shuai // Computational Optimization & Applications;Dec2011, Vol. 50 Issue 3, p525 

    Portfolio selection with higher moments is a NP-hard nonconvex polynomial optimization problem. In this paper, we propose an efficient local optimization approach based on DC (Difference of Convex functions) programming-called DCA (DC Algorithm)-that consists of solving the nonconvex program by...

  • A Portfolio Optimality Test Based on the First-Order Stochastic Dominance Criterion. Kopa, Miloš; Post, Thierry // Journal of Financial & Quantitative Analysis;Oct2009, Vol. 44 Issue 5, p1103 

    Existing approaches to testing for the efficiency of a given portfolio make strong parametric assumptions about investor preferences and return distributions. Stochastic dominance-based procedures promise a useful nonparametric alternative. However, these procedures have been limited to...

  • Mean-Variance and Mean-Gini Analyses to Portfolio Optimization in Malaysian Stock Market. Jaaman, Saiful Hafizah; Lam, Weng Hoe // Economics & Finance Review;Apr2012, Vol. 2 Issue 2, p60 

    The mean-variance (MV) model is commonly used in portfolio optimization for comparing uncertain prospects. This model however relies strictly on the assumptions that the returns of assets follow normal distribution or the investor's utility function is quadratic. In reality these two conditions...

  • Artificial Bee Colony Algorithm for Portfolio Optimization Problems. Zhen Wang; Sanyang Liu; Xiangyu Kong // International Journal of Advancements in Computing Technology;Mar2012, Vol. 4 Issue 4, p8 

    In this paper, a cardinality constrained mean-variance model is introduced for the portfolio optimization problems. This model is a mixed quadratic and integer programming problem for which efficient algorithms do not exist. The use of heuristic algorithms in this case is necessary. Some studies...


Read the Article


Sorry, but this item is not currently available from your library.

Try another library?
Sign out of this library

Other Topics