The Endowment Model and Modern Portfolio Theory

51 Pages Posted: 24 Feb 2019 Last revised: 14 Dec 2021

See all articles by Stephen G. Dimmock

Stephen G. Dimmock

National University of Singapore; Asian Bureau of Finance and Economic Research (ABFER)

Neng Wang

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

Jinqiang Yang

Columbia University; Shanghai University of Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: December 13, 2021

Abstract

We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze the ``endowment model,'' widely adopted by institutional investors such as pension funds, university endowments, and sovereign wealth funds. In the model, the alternative asset has a lock-up, but can be liquidated {at any time} by paying a proportional cost. We model how investors can engage in liquidity diversification by investing in multiple illiquid alternative assets with staggered lock-up expirations, and show that doing so increases alternatives allocations and investor welfare. We show how illiquidity from lock-ups interacts with illiquidity from secondary market transaction costs resulting in endogenous and time-varying rebalancing boundaries. We extend the model to allow crisis states and show that increased illiquidity during crises causes holdings to deviate significantly from target allocations.

Keywords: endowment model, portfolio choice, liquidity, modern portfolio theory, asset allocation, alternative assets

JEL Classification: G11, G23

Suggested Citation

Dimmock, Stephen G. and Wang, Neng and Yang, Jinqiang, The Endowment Model and Modern Portfolio Theory (December 13, 2021). Columbia Business School Research Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=3330919 or http://dx.doi.org/10.2139/ssrn.3330919

Stephen G. Dimmock (Contact Author)

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Neng Wang

Columbia University - Columbia Business School, Finance ( email )

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Jinqiang Yang

Columbia University ( email )

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Shanghai University of Finance and Economics ( email )

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