.... but not as much as Ranjan Badhuri implies in his article in

allaboutalpha.com
Ranjan writes about a game where liquidity pays:

The game consists of a hat that contains 6 black balls and 4 white balls. The player picks balls from the hat and gains $1 for each white ball, and loses $1 for each black ball. The selection is done without replacement. At the end of each pick, the player may choose to stop or continue. The player has the right to refuse to play (i.e. not pick any balls at all). Given these rules, and a hat containing 6 black balls and 4 white balls, would you play? (Why?)

Mathematically one can prove that there is a POSITIVE expected value (of 1/15) in playing this game, so one SHOULD play! The ability to stop any time is analogous to perfect liquidity (i.e. being able to pull out of an investment at any time without the action having an impact on the value of the investment). This value of liquidity helps overcome the imbalance between the black and white balls, and thus makes this game profitable. This is interesting from a behavioral finance point of view, since it seems to suggest that humans are wired such that they will tend to underestimate the value of liquidity.

The problem with this argument is that investing is a different game from this one. The game he describes is extremely path dependent, as the probability of outcomes after each step is very much changed by past outcomes.

If you want to make a financial argument regarding the investment performance of hedge funds - with or without lockups - then real financial data should be used in my opinion.

Interested in your thoughts,

Jonathan Starr