"Locked Up by a Lockup: Valuing Liquidity as a Real Option"
©
Financial Management,
2010
Volume: 39
|
Issue: 3
|
Pages: 1069-1096
Publication type: Journal article
Research Archive Topic: Business Economics and Public Policy, Capital Markets and Investments, Corporate Finance
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.
This is the pre-peer reviewed version of the article, which has been published in final form at Financial Management.
Each author name for a Columbia Business School faculty member is linked to a faculty research page, which lists additional publications by that faculty member.
Each topic is linked to an index of publications on that topic.