![]() In addition, cash payouts by private equity funds are also uncertain, although they are significant, because of the bounded life cycle of the funds. The timing and size of the capital calls are not known until they are announced, and usually there is a substantial lag between the time at which capital is committed to a fund and the time at which that capital is actually drawn for investment. The private equity fund investor first makes an initial capital commitment and later transmits specific amounts of capital to the general partner in response to capital calls (or capital drawdowns). Second, private equity fund investments involve specific dynamics of capital drawdowns and distributions. Private equity funds typically have maturities of ten to fourteen years, and secondary markets for private equity fund positions are still highly inefficient, making it costly for investors to sell their positions. First, private equity fund investments are illiquid and long term. Private equity funds have at least two key institutional features that differentiate them from traditional investments in traded stocks or bonds and make risk management a challenging task. Finally, sensitivity analyses show the impact of changes in the main model parameters on risk measures. A model extension also studies the dynamics of the risk measures for portfolios of funds and develops a novel dynamic commitment strategy. The model is calibrated with historical data of buyout funds, and the dynamics of the developed risk measures are illustrated for a single fund investment using Monte Carlo simulations. Underlying the framework is a stochastic model for the value and cashflow dynamics of private equity funds, which allows us to derive three dynamic risk measures for private equity fund investments: value-at-risk, liquidity-adjusted value-at-risk and cashflow-at-risk. This paper develops a comprehensive risk management framework for private equity fund investments, which captures the three main sources of risks that private equity investors face when investing in the asset class: market risk, liquidity risk and cashflow risk. ![]() Although risk management has been explored thoroughly in financial modeling for over three decades, there is still a limited understanding of how to correctly quantify and manage the risks of investing in private equity, which continues to hinder our understanding of the risks associated with other traditional asset classes.
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