Abstract

We show investors’ beliefs can explain the apparent undervaluation of buyout private equity (PE) funds. The value of PE funds, by finance principles, corresponds to expected discounted cash flows. Therefore, the undervaluation may stem from an incorrect stochastic discount factor (SDF) or a discrepancy between investors’ beliefs and the true distribution of discounted cash flows. We estimate investors’ beliefs from PE cash flows. Estimated beliefs are consistent with other evidence, including PE surveys. We find that investors’ pessimism about PE relative to public markets, rather than SDF misspecification or omitted pricing factors, explains the undervaluation.