Risk, returns and optimal holdings of private equity: A survey of existing approaches

This paper surveys the academic literature that examines the risks and returns of private equity investments, optimal private equity allocation, and compensation contracts for private equity firms. Empirical evidence shows that the irregular nature of private equity investments complicates the estimation and interpretation of standard risk and return measures. These complications have led to substantial disparity in performance estimates reported across studies. Moreover, studies suggest that the illiquidity and transaction costs inherent in private equity investments have substantial implications for optimal holdings of these assets. Finally, studies of contracts governing the relationships between investors, private equity funds and underlying portfolio companies suggest that these contracts address both moral hazard and information frictions, which typically results in substantial management and performance fees earned by the private equity firms.