Abstract
We study private equity in a dynamic general equilibrium model and ask two questions: (i) Why does the investment of venture funds respond more strongly to the business cycle than that of buyout funds? (ii) Why are venture fund returns higher than those of buyout? On (i), venture brings in new capital whereas buyout largely reorganizes existing capital; this can explain the stronger co-movement of venture with aggregate Tobin’s Q. On (ii), the cost of reorganized capital has been high compared to new capital. Our model embodies this logic and fits the data on investment and returns well. At the estimated parameters, the two PE sectors together contribute between 7 and 11% of observed growth relative to the extreme case where private equity is absent. Using an alternative plausible measure of PE excess returns in the literature, this contribution could be as low as 5.8–9.7%.
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