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The Endowment Model and Modern Portfolio Theory

Author

Listed:
  • Stephen G. Dimmock

    (National University of Singapore, Singapore 119077; Asian Bureau of Finance and Economic Research, Singapore 117592)

  • Neng Wang

    (Asian Bureau of Finance and Economic Research, Singapore 117592; Columbia Business School, Columbia University, New York, New York 10027; Cheung Kong Graduate School of Business, Beijing 100006, China; National Bureau of Economic Research, Cambridge, Massachusetts 02138)

  • Jinqiang Yang

    (School of Finance, Shanghai University of Finance and Economics, Shanghai, China 200437; Shanghai Institute of International Finance and Economics, Shanghai 200433, China)

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 lockup 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 lockup expirations and show that doing so increases alternatives allocations and investor welfare. We show how illiquidity from lockups 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.

Suggested Citation

  • Stephen G. Dimmock & Neng Wang & Jinqiang Yang, 2024. "The Endowment Model and Modern Portfolio Theory," Management Science, INFORMS, vol. 70(3), pages 1554-1579, March.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:3:p:1554-1579
    DOI: 10.1287/mnsc.2023.4759
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