The Endowment Model and Modern Portfolio Theory
49 Pages Posted: 24 Feb 2019
Date Written: February 7, 2019
We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze conditions under which the “Endowment Model,” used by some large institutional investors such as university endowments, does or does not work. The alternative asset has a lock-up, but can be voluntarily liquidated at any time at a cost. Quantitatively, our model’s results match the average level and cross-sectional variation of university endowment funds’ spending and asset allocation decisions. We show that asset allocations and spending crucially depend on the alternative asset’s expected excess return, risk unspanned by public equity, and investors’ preferences for inter-temporal spending smoothing.
Keywords: endowment model, portfolio choice, illiquid assets, illiquidity, modern portfolio theory, asset allocation, alternative assets, alternative investments
JEL Classification: G11, G23
Suggested Citation: Suggested Citation