Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:


On the Suitability of the Calibration of Private Equity Risk in the Solvency II Standard Formula

A new EDHEC study, sponsored by the Association Française des Investisseurs en Capital, calls into question the method and the data used by the European regulator to measure the risk of private equity investments, in particular the correlation coefficient of performance of private equity and that of listed equities.

The drawing-up of Solvency II prudential rules has become a matter of major concern for the private equity sector. Its financial impact can be large. As an example, in the French market, in 2007, the total investments in private equity represented €22bn in the balance sheet of insurance companies (FFSA 2008).

They finance 21% of the funds raised (AFIC); thus becoming the leading national investors in unlisted stocks. The current measure for private equity risk, used by the European regulator, leads to a correlation of 0.75 between the performance of private equity and that of listed equities. It is likely to dissuade insurers from investing in this class of assets. The EDHEC Financial Analysis and Accounting Research Centre study examines the robustness of this correlation coefficient and the methodology used to obtain this value.

In addition to casting doubt over the use of VaR (Value at Risk), which requires the implementation of correlation matrices that have been very controversial to date, the EDHEC study questions the representativeness of the LPX50 index selected by the regulator to measure the capital required for private equity investment risk. This index, which is defined on the basis of the stock prices of the fifty largest listed private equity firms in the world (i) is not representative of investments of European insurance companies, either on a geographical level or as a representation of the weight of investments in venture and buy-out, (ii) does not reflect the non-liquid contractual nature of investments in private equity, and (iii) as a result of the underlying investments, the LPX50 poses an idiosyncratic risk that is added to the risk of investment in private equity.

To correct the identified drawbacks of the CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) approach, EDHEC’s proposal involves replacing the LPX50 index with a benchmark that is more representative of insurance portfolios invested in private equity. The analysis is based on the performance of private equity funds for various investment classes and geographical zones, taken from the Thomson One database. In accordance with the practices of the private equity industry and academic approaches, the EDHEC Financial Analysis and Accounting Research Centre calculated the internal rates of return (IRR) of private equity funds by vintage year, and then measured the return of an equivalent investment in the MSCI indices, with the same portfolio structure as the private equity benchmark (vintage year, incoming and outgoing cash flows, geographic zone). This index is known as the Public Market Equivalent Plus (PME +).

The correlation between private equity and listed market performance is measured using four families of private equity investments (two geographical zones combined with two types of investment: buy-out and venture). In order to provide an optimal reflection of European insurance companies’ investments, these four families were then aggregated into a single portfolio. The results (both by family and for the aggregated portfolio) show that private equity performance is significantly less correlated to that of listed equity markets than assumed in the 0,75 correlation coefficient selected by the CEIOPS ; it lies between 0,11 and 0,54 according to the geographical zone and the type of investment.

Finally, the study shows through simulations the impact of the level of the correlation coefficient (representing diversification in investments) not only on the capital requirement for equity risk but also on the marginal cost of the capital requirement as a consequence of asset reallocation between listed equities and private equity.

This study has received support from the British Private Equity and Venture Capital Association, BVK, the European Private Equity and Venture Capital Association, and was presented to the Ministry of Economy at the Prudential Regulatory Authority.

Joanne Finlay | EDHEC Research Highlights
Further information:

More articles from Studies and Analyses:

nachricht Diagnoses: When Are Several Opinions Better Than One?
19.07.2016 | Max-Planck-Institut für Bildungsforschung

nachricht High in calories and low in nutrients when adolescents share pictures of food online
07.04.2016 | University of Gothenburg

All articles from Studies and Analyses >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: New 3-D wiring technique brings scalable quantum computers closer to reality

Researchers from the Institute for Quantum Computing (IQC) at the University of Waterloo led the development of a new extensible wiring technique capable of controlling superconducting quantum bits, representing a significant step towards to the realization of a scalable quantum computer.

"The quantum socket is a wiring method that uses three-dimensional wires based on spring-loaded pins to address individual qubits," said Jeremy Béjanin, a PhD...

Im Focus: Scientists develop a semiconductor nanocomposite material that moves in response to light

In a paper in Scientific Reports, a research team at Worcester Polytechnic Institute describes a novel light-activated phenomenon that could become the basis for applications as diverse as microscopic robotic grippers and more efficient solar cells.

A research team at Worcester Polytechnic Institute (WPI) has developed a revolutionary, light-activated semiconductor nanocomposite material that can be used...

Im Focus: Diamonds aren't forever: Sandia, Harvard team create first quantum computer bridge

By forcefully embedding two silicon atoms in a diamond matrix, Sandia researchers have demonstrated for the first time on a single chip all the components needed to create a quantum bridge to link quantum computers together.

"People have already built small quantum computers," says Sandia researcher Ryan Camacho. "Maybe the first useful one won't be a single giant quantum computer...

Im Focus: New Products - Highlights of COMPAMED 2016

COMPAMED has become the leading international marketplace for suppliers of medical manufacturing. The trade fair, which takes place every November and is co-located to MEDICA in Dusseldorf, has been steadily growing over the past years and shows that medical technology remains a rapidly growing market.

In 2016, the joint pavilion by the IVAM Microtechnology Network, the Product Market “High-tech for Medical Devices”, will be located in Hall 8a again and will...

Im Focus: Ultra-thin ferroelectric material for next-generation electronics

'Ferroelectric' materials can switch between different states of electrical polarization in response to an external electric field. This flexibility means they show promise for many applications, for example in electronic devices and computer memory. Current ferroelectric materials are highly valued for their thermal and chemical stability and rapid electro-mechanical responses, but creating a material that is scalable down to the tiny sizes needed for technologies like silicon-based semiconductors (Si-based CMOS) has proven challenging.

Now, Hiroshi Funakubo and co-workers at the Tokyo Institute of Technology, in collaboration with researchers across Japan, have conducted experiments to...

All Focus news of the innovation-report >>>



Event News

#IC2S2: When Social Science meets Computer Science - GESIS will host the IC2S2 conference 2017

14.10.2016 | Event News

Agricultural Trade Developments and Potentials in Central Asia and the South Caucasus

14.10.2016 | Event News

World Health Summit – Day Three: A Call to Action

12.10.2016 | Event News

Latest News

New method increases energy density in lithium batteries

24.10.2016 | Power and Electrical Engineering

International team discovers novel Alzheimer's disease risk gene among Icelanders

24.10.2016 | Life Sciences

New bacteria groups, and stunning diversity, discovered underground

24.10.2016 | Life Sciences

More VideoLinks >>>