Country Funds and Asymmetric Information

Closed-end country funds trade in New York at their price. Their Net Asset Value (NAV) represent the value of the underlying assets, usually traded in each particular country. If the holders of the underlying assets have more information about local assets than the country fund holders, changes in NAVs will tend to explain future changes in prices but not vice versa. This paper shows that most NAVs appear exogenous; while most prices reject exogeneity. Past changes in NAVs and discounts predict current prices more frequently than prices and discounts predict NAVs. The price (NAV) adjustment coefficients are low and negatively correlated with the local (foreign) market variability--but not with the fund price (NAV) variability. These findings are consistent with the existence of asymmetric information in international capital markets. The appendix introduces a model of asymmetric information, that rationalizes our empirical findings. Different perceived risk makes foreign investors willing to less pay for local assets than domestic investors. Therefore, country fund prices (driven mainly by small U.S. investors) tend to be lower than NAVs (driven mainly by domestic and large foreign investors). Two other propositions are derived. First, since NAVs and prices are linked by a long-run relationship, unusually large past discounts explain current NAVs and prices. Second, the presence of "noise traders" delays the adjustment toward the long-run equilibrium.