The Endowment Model and Modern Portfolio Theory

Stephen Dimmock, Neng Wang and Jinqiang Yang

No 25559, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze the “endowment model,” widely adopted by institutional investors such as pension funds, university endowments, and sovereign wealth funds. In the model, the alternative asset has a lock-up, but can be liquidated at any time by paying a proportional cost. We model how investors can engage in liquidity diversification by investing in multiple illiquid alternative assets with staggered lock-up expirations, and show that doing so increases alternatives allocations and investor welfare. We show how illiquidity from lock-ups interacts with illiquidity from secondary market transaction costs resulting in endogenous and time-varying rebalancing boundaries. We extend the model to allow crisis states and show that increased illiquidity during crises causes holdings to deviate significantly from target allocations.

JEL-codes: G11 G23 (search for similar items in EconPapers)
Date: 2019-02
New Economics Papers: this item is included in nep-fmk
Note: AP CF
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Citations: View citations in EconPapers (4)

Published as Stephen G. Dimmock & Neng Wang & Jinqiang Yang, 2024. "The Endowment Model and Modern Portfolio Theory," Management Science, vol 70(3), pages 1554-1579.

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