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

Aleksandr Ermakov; Benjamin Holcblat

doi:10.2139/ssrn.4629451

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

Aleksandr Ermakov, Benjamin Holcblat

A&F Accounting & Finance

University Of Luxembourg

Research output: Preprint/Working paper › Working paper

Abstract

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.

Original language	English
Publisher	SSRN
Pages	1-79
Number of pages	79
DOIs	https://doi.org/10.2139/ssrn.4629451
Publication status	Unpublished - 30 Oct 2024

Keywords

subjective beliefs
private equity funds
empirical likelihood
survey data
investors' expectations
relative entropy

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10.2139/ssrn.4629451

Cite this

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title = "Believe it or Not: The Role of Investor Beliefs for Private Equity Valuation",

abstract = "We show investors{\textquoteright} 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{\textquoteright} beliefs and the true distribution of discounted cash flows. We estimate investors{\textquoteright} beliefs from PE cash flows. Estimated beliefs are consistent with investors{\textquoteright} sentiment surveys. We find that investors{\textquoteright} pessimism about PE relative to public markets, rather than SDF misspecification, offers a potential explanation for PE funds{\textquoteright} undervaluation.",

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N2 - 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.

AB - 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.

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KW - empirical likelihood

KW - survey data

KW - investors' expectations

KW - relative entropy

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

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Keywords

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