A Rational Model of the Closed-End Fund Discount
AbstractThe 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.
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Date of creation: Apr 2004
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Find related papers by JEL classification:
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-06-07 (All new papers)
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