Evaluating Private Equity Performance Using Stochastic Discount Factors

We examine the performance of 2,750 private equity funds incepted during 1979-2008 using the discount factors implied by the two leading consumption-based asset pricing models (CBAPMs): Habit Formation and Long-run Risks. Our approach is motivated by the observation that investment mandates and cash flow patterns of university endowments and public pension funds are strongly consistent with the preferences of a representative investor in those models. Under these discount factors, venture capital did not destroy value in post-2000 vintages and has outperformed buyouts and generalists in the full sample, in contrast to CAPM-based evidence. Also we find that 2007-08 venture vintages has been on track to provide a relatively good hedge for consumption shocks during and post crisis in comparison to buyout funds. Moreover, there is virtually no spike in private equity excess returns in late 90s according to CBAPMs.