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

Andrew Ang

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Nicolas P. B. Bollen

Vanderbilt University - Finance

October 21, 2008

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 investors 1.5% of their initial investment. The magnitude is sensitive to a fund's age, expected return, and the liquidation cost upon failure. The cost of illiquidity can exceed 10% if the hedge fund manager suspends withdrawals.

Number of Pages in PDF File: 49

Keywords: Cost of illiquidity, hedge fund valuation, exercise restriction, redemption notice period, lockup, suspension clause

JEL Classification: G13, G23, C63

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Date posted: October 30, 2008 ; Last revised: November 17, 2012

Suggested Citation

Ang, Andrew and Bollen, Nicolas P. B., Locked Up by a Lockup: Valuing Liquidity as a Real Option (October 21, 2008). Available at SSRN: http://ssrn.com/abstract=1291842 or http://dx.doi.org/10.2139/ssrn.1291842

Contact Information

Andrew Ang
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Nicolas P.B. Bollen (Contact Author)
Vanderbilt University - Finance ( email )
401 21st Avenue South
Nashville, TN 37203
United States
HOME PAGE: http://mba.vanderbilt.edu/faculty/nbollen.cfm

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