Being Locked Up Hurts

40 Pages Posted: 16 Feb 2009 Last revised: 24 Jul 2014

See all articles by Frans de Roon

Frans de Roon

Tilburg University - Department of Finance

Jinqiang Guo

Tilburg University, Department of Finance

Jenke ter Horst

TIAS School for Business and Society

Multiple version iconThere are 2 versions of this paper

Date Written: August 10, 2010

Abstract

A lockup period for hedge funds restricts a multi-period investor's ability to rebalance his portfolio and has non-trivial effects on the allocation decision and portfolio efficiency. Investors compensate for a hedge fund lockup period by making adjustments to their equity and bond holdings. Adding hedge funds with a lockup period to the portfolio of stocks and bonds generates large, negative hedge demands for stocks. More importantly, an investor with a portfolio of stocks, bonds and hedge funds under both the unconditional strategy and conditional strategy is hurt by the presence of a hedge fund lockup period. In an unconditional setting, we find a Sharpe ratio of 1.10 for the portfolio of stocks, bonds and hedge funds adjusted for stale pricing, with a three-month lockup period for hedge funds and monthly rebalancing of stocks and bonds. For the same portfolio, but without a hedge fund lockup period, we find a significantly higher Sharpe ratio of 1.42. The certainty equivalent is 1.9%, i.e. the investor is willing to pay 1.9% per year in order to move to the ideal situation of unlimited rebalancing or no lockup.

Keywords: Multi-period asset allocation, hedge funds, lockup period

JEL Classification: G11, G12

Suggested Citation

de Roon, Frans A. and Guo, Jinqiang and ter Horst, Jenke R., Being Locked Up Hurts (August 10, 2010). EFA 2009 Bergen Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1342450 or http://dx.doi.org/10.2139/ssrn.1342450

Frans A. De Roon

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 1 3466 8361/3025 (Phone)
+31 1 3466 2875 (Fax)

Jinqiang Guo

Tilburg University, Department of Finance ( email )

P.O. Box 90153
Tilburg, DC 5000 LE
Netherlands

Jenke R. Ter Horst (Contact Author)

TIAS School for Business and Society ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

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