Latent Factors in Priuate Markets

Abstract

This thesis explores an innovative methodology for identifying latent risk factors in illiquid markets. By uncovering the true underlying volatility and solving for an optimal number of clusters, we identify four latent risk factors. These private factors consist of fund groupings that can only be partially explained by conventional fund characteristics. Furthermore, our study reveals that private markets offer unique exposures, constituting an additional source of factor risk premiums beyond those found in public asset pricing factors. Investors can achieve exposure to these risk premiums and the associated diversification benefits by constructing portfolios based on certain fund characteristics such as geographical focus, investment strategy, and fund size.