The time-varying risk of listed private equity

Structure and stability of private equity market risk are still nearly unknown, since market prices are mostly unobservable for this asset class. This paper aims to fill this gap by analyzing market risks of listed private equity vehicles. We show that aggregate market risk varies strongly over time and is positively correlated with the market return variance. Cross-sections of market risk are highly unstable, whereas ranks of individual vehicles within yearly subsamples change slightly less over time. Individual CAPM betas are predictable only up to two to three years into the future and quickly converge to a stationary distribution when measured in risk classes in an empirical Markov transition matrix. We suspect that market risk of private equity is affected by factors unique to this sector: acquisitions and divestments that constantly rebalance portfolios, scarcity of information about portfolio companies, and rapid changes within portfolio companies. Unstable market risk seems to be a fundamental characteristic of private equity assets, which must be incorporated into valuation and portfolio allocation processes by long-term private equity investors. Large increases in systematic risk in recent years cast doubt on diversification benefits of private equity in times of crisis.