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Diversification in lottery-like features and portfolio pricing discount: Evidence from closed-end funds

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  • Liu, Xin

Abstract

Why do portfolios often trade at discounts relative to the sum of their components? I provide a new explanation based on the diversification in lottery-like features. I argue that portfolios trade at discounts when their components exhibit a strong lottery-like feature but a low tendency of producing extreme payoffs together. This discount can be partially mitigated if lottery-like components tend to produce extreme payoffs at the same time. I use the closed-end fund setting to provide empirical supports for this explanation. My findings support prospect theory from an alternative perspective and provide a novel explanation for the closed-end fund puzzle.

Suggested Citation

  • Liu, Xin, 2021. "Diversification in lottery-like features and portfolio pricing discount: Evidence from closed-end funds," Journal of Empirical Finance, Elsevier, vol. 62(C), pages 1-11.
    • Handle: RePEc:eee:empfin:v:62:y:2021:i:c:p:1-11
    DOI: 10.1016/j.jempfin.2021.02.001
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    More about this item

    Keywords

    Closed-end fund discount; Cumulative prospect theory; Diversification; Lottery-like feature; CoMax;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G40 - Financial Economics - - Behavioral Finance - - - General

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