Abstract
We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze the “endowment model,” popularized by university endowment funds. The alternative asset has a lock-up, but can be liquidated prior to the lock-up's expiration by paying a proportional cost. The quantitative results match the average level and cross-sectional variation of endowments' spending and asset allocation decisions. Asset allocation and spending depend on the alternative asset's expected excess return, unspanned risk, and preferences for inter-temporal smoothing. We extend the model to allow crisis states, and show that increased illiquidity during crises causes holdings to deviate significantly from targets allocations.
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