Locked Up by a Lockup: Valuing Liquidity as a Real Option

Andrew Ang and Nicolas P.B. Bollen

No 15937, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Hedge funds often impose lockups and notice periods to limit the ability of investors to withdraw capital. We model the investor's decision to withdraw capital as a real option and treat lockups and notice periods as exercise restrictions. Our methodology incorporates time-varying probabilities of hedge fund failure and optimal early exercise. We estimate a two-year lockup with a three-month notice period costs approximately 1% of the initial investment for an investor with CRRA utility and risk aversion of three. The cost of illiquidity can easily exceed 10% if the hedge fund manager can arbitrarily suspend withdrawals.

JEL-codes: G11 G23 G24 G32 G33 (search for similar items in EconPapers)
Date: 2010-04
Note: AP
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Citations: View citations in EconPapers (15)

Published as Andrew Ang & Nicolas P.B. Bollen, 2010. "Locked Up by a Lockup: Valuing Liquidity as a Real Option," Financial Management, Financial Management Association International, vol. 39(3), pages 1069-1096, 09.

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