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

Financial Management, Vol. 39, No. 3, pp. 1069-1096, November 2008

49 Pages Posted: 21 Oct 2011  

Andrew Ang

BlackRock, Inc

Nicolas P. B. Bollen

Vanderbilt University - Finance

Multiple version iconThere are 4 versions of this paper

Date Written: 2010

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.

Suggested Citation

Ang, Andrew and Bollen, Nicolas P. B., Locked Up by a Lockup: Valuing Liquidity as a Real Option (2010). Financial Management, Vol. 39, No. 3, pp. 1069-1096, November 2008 . Available at SSRN: https://ssrn.com/abstract=1946500

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Nicolas P.B. Bollen

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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