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Closed-End Fund Discounts in a Rational Agent Economy

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  • Matthew Spiegel

    (University of California at Berkeley)

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    Abstract

    Nearly any standard financial model concludes that two assets with identical cash flows must sell for the same price. Alas, closed-end mutual fund company share prices seem to violate this fundamental tenant. Even when one considers several standard frictions, such as taxes and agency costs, classical financial models cannot explain the large persistent discounts found within the data. While the standard financial markets model may not explain the existence of large closed- end fund discounts, this paper shows that a rather close version of it does. In an otherwise frictionless market, if asset supplies vary randomly over time and agents posses finite lives a closed-end mutual fund's stock price may not track its net asset value. Furthermore, the analysis provides a number of conditions under which these discrepancies will lead to the existence of systematic discounts for the mutual fund's shares. In addition, the model provides predictions regarding the correlation between current closed-end fund discounts and current changes in stock prices and future changes in corporate productivity. As the analysis shows the same parameter values that lead to systematic discounts also lead to other fund price characteristics that resemble many of the results found within empirical studies.

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    File URL: http://128.118.178.162/eps/fin/papers/9712/9712002.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Finance with number 9712002.

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    Length: 39 pages
    Date of creation: 08 Dec 1997
    Date of revision:
    Handle: RePEc:wpa:wuwpfi:9712002

    Note: Type of Document - PDF; prepared on IBM PC; to print on LaserJet 4P, or Adobe Acrobat Compatible Printer; pages: 39; figures: included. None
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    Web page: http://128.118.178.162

    Related research

    Keywords: Closed-end funds; arbitrage; overlapping generations;

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    References

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    1. Froot, Kenneth A & Scharftstein, David S & Stein, Jeremy C, 1992. " Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation," Journal of Finance, American Finance Association, vol. 47(4), pages 1461-84, September.
    2. Swaminathan, Bhaskaran, 1996. "Time-Varying Expected Small Firm Returns and Closed-End Fund Discounts," Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 845-87.
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    7. Barclay, M.J. & Holderness, C.G. & Pontiff, J., 1991. "Private Benefits form Block Ownership and Discounts on Closed-end Funds," Papers 91-01, Rochester, Business - Financial Research and Policy Studies.
    8. Vayanos, Dimitri, 1998. "Transaction Costs and Asset Prices: A Dynamic Equilibrium Model," Review of Financial Studies, Society for Financial Studies, vol. 11(1), pages 1-58.
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    11. Brickley, James A & Manaster, Steven & Schallheim, James, 1991. "The Tax-Timing Option and the Discounts on Closed-End Investment Companies," The Journal of Business, University of Chicago Press, vol. 64(3), pages 287-312, July.
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    14. Chen, Nai-fu & Kan, Raymond & Miller, Merton H, 1993. " Are the Discounts on Closed-End Funds a Sentiment Index? A Rejoinder," Journal of Finance, American Finance Association, vol. 48(2), pages 809-10, June.
    15. Thompson, Rex, 1978. "The information content of discounts and premiums on closed-end fund shares," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 151-186.
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    17. Chopra, Navin, et al,, 1993. " Yes, Discounts on Closed-End Funds Are a Sentiment Index: Summing Up," Journal of Finance, American Finance Association, vol. 48(2), pages 811-12, June.
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    Cited by:
    1. Lily Qiu & Ivo Welch, 2004. "Investor Sentiment Measures," NBER Working Papers 10794, National Bureau of Economic Research, Inc.

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