DP16910 Capital Commitment

Author(s):	Elise Gourier, Ludovic Phalippou, Mark Westerfield
Publication Date:	January 2022
Keyword(s):	Capital commitment, commitment risk, liquidity premium, private equity
JEL(s):	G11, G12
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=16910

Over ten trillion dollars are allocated to private market funds that require outside investors to commit to transferring capital on demand; most of these funds are Private Equity (PE). We show within a novel dynamic portfolio allocation model that ex-ante commitment has large effects on investors' portfolios and welfare, and we quantify those effects. Investors are under-allocated to PE and are willing to pay a larger premium to adjust the quantity committed than to eliminate other frictions, like timing uncertainty and limited tradability. Perhaps counter-intuitively, commitment risk premiums increase with secondary market liquidity and they do not disappear even if investments are spread over many funds.