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A Rational Model of the Closed-End Fund Discount

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  • Jonathan Berk
  • Richard Stanton

Abstract

The discount on closed-end funds is widely accepted as proof of investor irrationality. We show,however, that a parsimonious rational model can generate a discount that exhibits many of the characteristics observed in practice. The only required features of the model are that managers have (imperfectly observable) ability to generate excess returns; they sign long-term contracts guaranteeing them a fee each year equal to a fixed fraction of assets under management; and they can leave to earn more money elsewhere if they turn out to be good. With these assumptions, time-varying discounts are not an anomaly in a rational world with competitive investors -- they are required.

Suggested Citation

  • Jonathan Berk & Richard Stanton, 2004. "A Rational Model of the Closed-End Fund Discount," NBER Working Papers 10412, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:10412
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    References listed on IDEAS

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    1. Exotic Investing: Closed End Funds
      by PKamp3 in DQYDJ.net on 2009-07-21 19:52:25

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    2. M. Caporin & A. Lanzavecchia & V. Lippoli, 2012. "I Fondi Immobiliari Italiani: Nav Discount E Valutazioni Degli Esperti Indipendenti," Economics Department Working Papers 2012-EF01, Department of Economics, Parma University (Italy).
    3. Lily Qiu & Ivo Welch, 2004. "Investor Sentiment Measures," NBER Working Papers 10794, National Bureau of Economic Research, Inc.
    4. Utku Uygur & Oktay Taş, 2014. "The impacts of investor sentiment on returns and conditional volatility of international stock markets," Quality & Quantity: International Journal of Methodology, Springer, vol. 48(3), pages 1165-1179, May.

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    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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