Market-Conditional Distribution Pacing in Private Equity NAV Estimation; The Effect of Agricultural Derivatives on the 2008 World Food Crisis

The technical portion of my thesis, titled “Market-Conditional Distribution Pacing in Private Equity NAV Estimation,” investigates whether private equity genuinely offers superior risk-adjusted returns compared to public market investments. Private equity is widely favored by institutional allocators, such as pension funds and endowments, primarily because it has historically outperformed public markets. Proponents attribute the outperformance of private equity to the exploitation of greater market inefficiencies in private markets and improved operational effectiveness under private ownership. However, many critics argue this outperformance arises from excessive leverage, opaque valuation practices, and ethical shortcomings due to inadequate oversight.
One key issue identified by many private equity investors is that private equity valuation practices often understate true investment risk, utilizing quarterly performance reports that obscure real-time market dynamics. Funds commonly elevate asset valuations swiftly but delay marking down their investments in periods of stress, artificially smoothing returns and creating an illusion of reduced volatility. This practice, termed "Volatility Laundering," results in institutional portfolios appearing less risky due to their significant private equity allocations, even amidst market downturns.
The technical portion of my thesis employs a state space model to correct reported valuations, enabling a more accurate assessment of real-time performance. Prior research has successfully demonstrated this model’s capability, and I expand its efficacy by incorporating additional external variables and adjusting for specific sectoral or geographical focuses of private equity funds. This refined approach aims to clarify whether private equity's perceived superior
risk-return tradeoff genuinely exists or if it is predominantly an artifact of valuation methodologies, ultimately providing institutional investors with a better understanding of the actual risks and returns of their private equity investments.
The 2008 World Food Crisis triggered severe spikes in global food prices, significantly impacting food security, particularly in developing countries. Staple food prices, notably rice, wheat, and corn, soared, with rice prices tripling in months and rising 31% in a single day during March 2008. This volatility exacerbated food insecurity for vulnerable populations, who spend over 60% of their income on food, causing widespread hardship and food riots globally.
One of the most commonly blamed systems for exascerbating the crisis is the commodity futures markets. These markets were initially established for price risk management among agricultural producers and processors. However, a dramatic increase in speculative investment, including from hedge funds and institutional investors through commodity index funds, fundamentally altered these markets. Futures contracts surged over 60% between 2005 and 2008, and speculative interest often exceeded actual commodity production. This "financialization" raised ethical and stability concerns, prompting intense debate on speculation's role in price volatility.
In the STS portion of my thesis, I argue that while fundamental economic factors, including droughts, biofuel policies, emerging market demand, and rising energy prices, undeniably contributed to rising prices, evidence suggests speculation amplified volatility. Commodity index funds, in particular, correlated with speculative bubbles in markets such as soybeans and oil. However, the evidence is mixed, with some studies arguing that speculation's impact was minimal or stabilizing.
In the STS portion of my thesis, I conduct a review using the Social Construction of Technology (SCoT) framework to evaluate the interactions among market participants, technology, and regulation. The analysis indicates speculative activities intensified volatility but generally improved market efficiency. Ultimately, we arrive at policy recommendations include stricter regulation against market manipulation, enhanced transparency, and position limits on speculative trading to prevent adverse impacts and reinforce global food security.
As a computer science student, there is not a direct link between the technical and STS portions of my thesis. They explore different domains, but both fundamentally deal with the problem of transparency and volatility in financial markets. Both analyses highlight the significance of transparency to prevent potential harms caused by volatility. In one case, volatility can have severe effects on food security and in another it can cause massive losses of capital for endowments and foundations. The technical analysis provides enhanced risk measurement tools for institutional investors in private equity, whereas the STS analysis explores how financial instruments originally intended to hedge agricultural risk have evolved into speculative tools, significantly impacting global food security.

School of Engineering and Applied Science

Bachelor of Science in Computer Science

Technical Advisor: Denis Nekipelov

STS Advisor: Joshua Earle