Journal of Risk

Modeling the exit cashflows of private equity fund investments

Christian Tausch, Axel Buchner and Georg Schlüchtermann

  • This paper develops a deal-level model for the exit cash flows of private equity funds.
  • The model jointly describes the exit timing and the performance of portfolio companies.
  • Deal-level data for buyout and venture capital funds are used for empirical estimation.
  • A Monte Carlo simulation example analyzes risk management applications.

Risk perception in private equity is notoriously difficult, as the cashflow patterns associated with private capital funds are not well understood at the underlying deal level. This paper analyzes the realized exit cashflows of individual portfolio companies in a joint modeling framework that describes both the exit timing and the exit performance. Specifically, we choose an exit timing model suited to the interval-censored nature of private equity deal data and an approach for the exit multiple (ie, the performance) appropriate for the high numbers of company defaults observed in private equity. The corresponding parametric joint model is estimated using the maximum likelihood method for a buyout and venture capital data set and applied in a Monte Carlo simulation example to demonstrate the suitability of our approach in a risk management context. The improved insights offered by risk analysis tools that can incorporate detailed company-level information may be of particular benefit to undiversified private equity fund investors.

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