NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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

Andrew Ang, Nicolas P.B. Bollen

NBER Working Paper No. 15937
Issued in April 2010
NBER Program(s):   AP

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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Document Object Identifier (DOI): 10.3386/w15937

Published: 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.

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