A liquidity haircut for hedge funds
Investors in hedge funds have learned to be cautious when making decisions due to problems of survivorship bias, autocorrelation and hidden optionality. Here, Hari Krishnan and Izzy Nelken show how to quantify such caution. By analysing the incentive structure of hedge fund managers using an option pricing approach, they derive a liquidity haircut to compensate for lockup periods, and an illiquidity premium that effectively increases volatility
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