Locked Up by a Lockup: Valuing Liquidity as a Real OptionCoauthor(s): 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 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.
Source: Financial Management
Ang, Andrew, and Nicolas P. B. Bollen. "Locked Up by a Lockup: Valuing Liquidity as a Real Option." Financial Management 39, no. 3 (Fall 2010): 1069-1096.
Date: Fall 2010