PT  - JOURNAL ARTICLE
AU  - Hans Esterhuizen
TI  - Convexity, Theta, and the Optionality of Investing in Private Companies
AID  - 10.3905/jpe.2013.16.4.031
DP  - 2013 Aug 31
TA  - The Journal of Private Equity
PG  - 31--36
VI  - 16
IP  - 4
4099  - https://pm-research.com/content/16/4/31.short
4100  - https://pm-research.com/content/16/4/31.full
AB  - Convexity is the degree to which small changes in the characteristics of an investment cause large changes in the investment’s value. The convexity of an investment is a primary driver of long-term returns across asset classes, especially in private equity. Private equity practitioners lack the language and tools necessary to speak articulately about convexity and have gravitated toward using ambiguous terms that lack quantification. The private equity industry needs to adopt the language and mathematics of fixed income in order to clarify the discussion and measurement of convexity. Convexity is more important when investing with long-term private equity capital because the propensity to undervalue the time component of convexity is far greater in an illiquid market.TOPICS: Private equity, statistical methods, analysis of individual factors/risk premia, fixed income and structured finance