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

Andrew Ang () and Nicolas P.B. Bollen

Financial Management, 2010, vol. 39, issue 3, 1069-1096

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.

Date: 2010
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https://doi.org/10.1111/j.1755-053X.2010.01104.x

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Working Paper: Locked Up by a Lockup: Valuing Liquidity as a Real Option (2010)
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