Believe it or Not: The Role of Investor Beliefs for Private Equity Valuation

We show investors’ beliefs can explain the undervaluation of buyout private equity (PE) funds. The value of PE funds, by finance principles, corresponds to expected cash flows discounted for time and risk. Therefore, the undervaluation may stem from an incorrect stochastic discount factor (SDF) or a difference between investors’ beliefs and the true distribution of discounted cash flows. We estimate investors’ beliefs from PE cash flows. Estimated beliefs are consistent with investors’ sentiment surveys. We find that investors’ pessimism about PE relative to public markets, rather than SDF misspecification, offers a potential explanation for PE funds’ undervaluation.