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

  • Andrew Ang
  • Nicolas P.B. Bollen

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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15937.

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Date of creation: Apr 2010
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Publication status: 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.
Handle: RePEc:nbr:nberwo:15937
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