Working Paper: NBER ID: w25559
Authors: Stephen G. Dimmock; Neng Wang; Jinqiang Yang
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: Dynamic portfolio choice; Illiquid alternative assets; Endowment model; Liquidity diversification
JEL Codes: G11; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity diversification (G19) | investor welfare (G24) |
| liquidity diversification (G19) | allocations to alternative assets (G11) |
| increased allocations to alternative assets (G23) | investor welfare (G24) |
| number of distinct alternative investments (G11) | optimal allocation to alternatives (D61) |
| number of distinct alternative investments (G11) | investor welfare (G24) |
| liquidity conditions (E41) | asset allocation (G11) |
| higher elasticity of intertemporal substitution (D15) | greater allocations to alternatives (G11) |