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We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze conditions under which the "Endowment Model," used by some large institutional investors such as university endowments, does or does not work. The alternative asset has a lock-up, but can be voluntarily liquidated at any time at a cost. Quantitatively, our model's results match the average level and cross-sectional variation of university endowment funds' spending and asset allocation decisions. We show that asset allocations and spending crucially depend on the alternative asset's expected excess return, risk unspanned by public equity, and investors' preferences for inter-temporal spending smoothing.
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Over the past two decades, endowments have become an increasingly important component of the typical university's resource base. We examine how U.S. doctoral institutions' endowment payout policies and spending decisions are affected by financial market shocks to endowments. While most endowments have formal payout policies intended to smooth payouts over time, we find that universities are more likely to deviate from these policies following negative (but not positive) shocks. These negative shocks have important economic effects on university activities. Specifically, we find that universities with larger negative endowment shocks are relatively more likely to: (1) reduce support staff (e.g., secretaries) and maintenance, but not administrators; (2) among less selective institutions, reduce expenditures on tenure-system faculty while increasing the average salary of adjuncts/lecturers; (3) make larger cuts to tenure-system faculty and secretarial support when their endowment portfolio is less liquid (i.e. higher allocations to alternative assets such as hedge funds); and (4) among more selective universities, reduce financial aid for students the following Fall and enroll fewer freshmen. We also find that universities increase hiring when there are negative endowment shocks to their peers. Thus, financial shocks have real effects on university operations, but with cross-sectional variation in how universities respond.
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Charitable donations are an important revenue source for many institutions of higher education. We explore how donations respond to economic and financial market shocks, accounting for both supply and demand channels through which these shocks operate. In panel data with fixed effects to control for unobservable differences across universities, we find that overall donations to higher education – and especially capital donations for university endowments or for buildings– are positively and significantly correlated with the average income and house values in the state where the university is located (supply effects). We also find that when a university suffers a negative endowment shock that is large relative to its operating budget, donations increase (demand effects). This is especially true for donations earmarked for current use. We conclude by discussing the importance of understanding how donations respond to economic shocks for effective financial risk management by colleges and universities.
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We measure ambiguity attitudes for a representative sample of US households using a custom-designed module in the American Life Panel. Ambiguity attitudes vary substantially across people: half are ambiguity averse, 12% are ambiguity neutral, and 37% are ambiguity seeking. Further, ambiguity attitudes depend on the likelihood of the ambiguous event: people tend to overweight low-likelihood ambiguous events and underweight high-likelihood events, a phenomenon called ambiguity-likelihood insensitivity. Consistent with theoretical predictions, higher ambiguity aversion is associated with less equity market participation, lower portfolio allocations to equities, and more retirement planning. High ambiguity-likelihood insensitivity is associated with a higher probability of being insured.
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We explore the relation between probability weighting and household portfolio underdiversification in a representative household survey, using custom-designed incentivized lotteries. On average, people display Inverse-S shaped probability weighting, overweighting the small probabilities of tail events. As theory predicts, our Inverse-S measure is positively associated with portfolio underdiversification, which results in significant Sharpe ratio losses. We match respondents' individual stock holdings to CRSP data and find that people with higher Inverse-S tend to pick stocks with positive skewness and hold positively-skewed equity portfolios. We show that these choices reflect preferences rather than probability unsophistication or limited financial knowledge.
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