“Explain decision risk and whether it is a more serious problem for PE or for commodity futures contracts”
The text says decision risk is the risk of abandoning a strategy at the worst or inopportune time. How would this be high for PE? Once invested they can’t exit due to lock-ups so I was thinking PE would be a barrier to decision risk, preventing the client from acting irrationally. The answer says, “The investor may be unable to exit and then assert they never understood the risks”.
How is this decision risk? What is this thing lol?
PE investment time horizon (lets say 15 years) is higher than the lockup period (5 years), so if the investor irrationally decides to abandon and remove his funds just after the lockup period, it would negatively affect the performance of the PE as it is still too soon for the PE to realise profits. On paper, the PE requires at least 5 years to realise its first profits. But in reality, the PE may need significantly more than 5 years to realise its first profits. The investor wants profits immediately after 5 years, and so will act irrationally if PE is not generating profits after 5 years.
Why dont PE suggest a larger lockup period? Because a larger lockup period will attract fewer clients for the PE.