Practical Applications of The Valuation of Illiquid Assets: A Focus on Private Equity and Real Estate

Abstract

In The Valuation of Illiquid Assets: A Focus on Private Equity and Real Estate in the Summer 2022 issue of the The Journal of Alternative Investments, Rajna Gibson Brandon, Martin Hoesli, and Jiajun Shan, all at the University of Geneva, demonstrate the benefits of an option-based approach to valuing illiquid assets. One of their main contributions to the existing literature is modeling the change in the value of the underlying venture capital fund as a mixed jump-diffusion process. Their results illustrate how following a naive net-present-value (NPV) rule leads to suboptimal investment timing by ignoring the option to wait. The option to wait to make subsequent investments and evaluate new information is valuable. Furthermore, the value of the option can be used to determine the appropriateness of VC fund fees, as it represents the right to invest in the underlying portfolio companies or properties.