The Endowment Model and Modern Portfolio Theory
52 Pages Posted: 24 Feb 2019 Last revised: 13 Sep 2021
Date Written: June 22, 2021
We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze the ``endowment model,'' popularized by university endowment funds. The alternative asset has a lock-up, but can be liquidated prior to the lock-up's expiration by paying a proportional cost. The quantitative results match the average level and cross-sectional variation of endowments' spending and asset allocation decisions. Asset allocation and spending depend on the alternative asset's expected excess return, unspanned risk, and preferences for inter-temporal smoothing. We extend the model to allow crisis states, and show that increased illiquidity during crises causes holdings to deviate significantly from targets allocations.
Keywords: endowment model, portfolio choice, liquidity, modern portfolio theory, asset allocation, alternative assets
JEL Classification: G11, G23
Suggested Citation: Suggested Citation