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

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  • Andrew Ang
  • Nicolas P.B. Bollen

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 constant relative risk aversion utility and risk aversion of three. The cost of illiquidity can easily exceed 10% if the hedge fund manager can arbitrarily suspend withdrawals." Copyright (c) 2010 Financial Management Association International..

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Bibliographic Info

Article provided by Financial Management Association International in its journal Financial Management.

Volume (Year): 39 (2010)
Issue (Month): 3 (09)
Pages: 1069-1096

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Handle: RePEc:bla:finmgt:v:39:y:2010:i:3:p:1069-1096

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Cited by:
  1. Ang, Andrew & Gorovyy, Sergiy & van Inwegen, Gregory B., 2011. "Hedge fund leverage," Journal of Financial Economics, Elsevier, vol. 102(1), pages 102-126, October.
  2. Hombert, Johan & Thesmar, David, 2014. "Overcoming limits of arbitrage: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 111(1), pages 26-44.
  3. Schaub, Nic & Schmid, Markus, 2013. "Hedge fund liquidity and performance: Evidence from the financial crisis," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 671-692.

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