Get access

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


  • Andrew Ang,

    1. Andrew Ang is the Ann F. Kaplan Professor of Business at the Columbia Business School, Columbia University in New York, NY.
    Search for more papers by this author
  • Nicolas P.B. Bollen

    1. Nicolas P.B. Bollen is the E. Bronson Ingram Professor of Finance at the Owen Graduate School of Management at Vanderbilt University in Nashville, TN.
    Search for more papers by this author

  • The authors thank an anonymous referee, Bill Christie (the editor), Emanuel Derman, Greg van Inwegen, Jacob Sagi, Hans Stoll, Neng Wang, seminar participants at Columbia University's Financial Engineering Practitioners Seminar, Cornell University, the University of Mississippi, Vanderbilt University, and Virginia Tech, as well as attendees of the First Conference on the Econometrics of Hedge Funds (Paris) and the Third Conference on Professional Asset Management (Rotterdam) for helpful comments. Support from the Financial Markets Research Center at Vanderbilt University and the Centre for Hedge Fund Research at Imperial College London is gratefully acknowledged.


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.