Markov chain models to estimate the premium for extended hedge fund lockups

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A lockup period for investment in a hedge fund is a time period after making the investment during which the investor cannot freely redeem his investment. It is routine to have a one-year lockup period, but recently the requested lockup periods have grown longer. We estimate the premium for such extended lockup, taking the point of view of a manager of a fund of funds, who has to choose between two investments in similar funds in the same strategy category, the first having a one-year lockup and the second having an n-year lockup. Assuming that the manager will rebalance his portfolio of hedge funds on a yearly basis, if permitted, we define the annual lockup premium as the difference between the rates of return from these investments. We develop a Markov chain model to estimate this lockup premium. By solving systems of equations, we fit the Markov chain transition probabilities to three directly observable hedge fund performance measures: the persistence of return, the variance of return and the hedge-fund death rate. The model quantifies the way the lockup premium depends on these parameters. Data from the TASS database are used to estimate the persistence, which is found to be statistically significant.
Publisher
John Wiley & Sons
Issue Date
2009-10
Language
English
Citation

WILMOTT JOURNAL, v.1, no.5-6, pp.263 - 293

ISSN
1759-6351
DOI
10.1002/wilj.24
URI
http://hdl.handle.net/10203/96849
Appears in Collection
MT-Journal Papers(저널논문)
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