Occupational Choice and the Private Equity Premium Puzzle
Social Science Research Network
This paper suggests a solution to what has become known as the "private equity premium puzzle". Moskowitz and Vissing-Jorgensen (2002, AER, forthcoming) have documented the risk-return structure and the portfolio allocation of private equity in the US. They find that average private equity ex-post returns are comparable to average ex-post returns on public equity, but also that the distribution of individual returns is very wide and skewed to the left. At the same time, investment in private
... tment in private equity is extremely concentrated with most entrepreneurial households investing the majority of their wealth in a single firm. They conclude that given the concentration in individual portfolios and the large idiosyncratic risk associated with private equity, investment in private firms seems to be dominated by investment in publicly traded equity for risk-averse individuals and term this finding the "private equity premium puzzle. They also discuss five factors which could represent the resolution of the puzzle: large non-measured pecuniary or non-pecuniary benefits of entrepreneurship, high risk tolerance, preference for skewness or non-rational expectations about private equity returns on the part of entrepreneurs.