CAPM & Co. Revisited - Modeling Risk and Return of Private Equity Funds

For years, research has been conducted to correctly model and predict the risk and return structures of Private Equity (PE) funds. Although past research has revealed valuable insight into the features of those funds, most risk and return model struggle with the dispersion of PE funds' returns, their illiquidity and the factors driving the returns. The goal of this paper is to develop a methodology to correctly determine the risk and return profiles of Private Equity funds given their respective characteristics of management skill, investment focus and investment stage. We overcome the shortcomings of prior models by applying new methods like adequate return distribution fitting on the investment level, K-means clustering, and Copulae which have not been used in this research field before in order to estimate dependencies of return distributions on the investment level to obtain a joint distribution on the fund level. Our model offers investors the possibility to estimate the risk and return profile of any selected fund by the respective funds's management features, investment focus and investment stage. Investors will thereby be able to choose a fund which matches their desired risk and return expectations, enabling them to maximize their investment utility