Private Equity and the Leverage Myth

Abstract

KEY FINDINGS n Why isn't the appropriately leveraged volatility of public companies a reasonable approximation of private equity volatility? The authors look for clues in the public markets where they find no association between volatility and leverage, counter to what financial theory would suggest. n The evidence suggests that the relationship between leverage and volatility is hopelessly obscured by a variety of confounding effects in both public and private markets. n This article arrives at the counterintuitive conclusion that private equity volatility is similar to public equity volatility despite its higher leverage. The likely explanation is that privately held companies are inherently less risky and thus able to bear greater leverage.