1
Q
Traditional explanations (1)
A
Agency cost: high mangmt fee and subpar expectations for future portf management
Explains (2) D but fails to explain
(1) why pay initial premium
(3) fee = constant % of NAV. Why fluctuations?
2
Q
Traditional expl (2)
A
Illiquidity =.
NAV exaggerates true value assets
- restricted stock h: hard to sell quickly. Inv value these assets less then the fund does -D. However they sell the same assets as the market does - regulation - why high D for large diversified funds still?
- Block discount h: fund owns a lot of same stock. When sell - supply increase by a lot and price will go down. So u get less then marginal yield per share expected and not NAV. Inv expect this - D. However, this counteracts with price increasing (D lowering) at the end!
3
Q
Traditional expl (3)
A
Tax liabilities
NAV needs to be adjusted for tax paid when assets are sold at the end
- Tax only explains 6% of D
- Its the price that increases at the end and not the NAV decreasing (acc to Tax Theory)
- Acc to TT, D should increase when market rises (bull) but we observe opposite. D decreases due to + IS
4
Q
Closed end fund fuzzle (4)
A
- Premium beginning = noice traders (irrational inv) are too optimistic and overreact. Entrepreneurs benefit.
- Discounts during life fund = systematic risk. Noice traders are unpredictable thus add risk. Holding CEF is riskier than holding its portfolio. *explains why NT don’t have to be pessimistic for here to be a D
- Fluctuations of discount= unpredictability of the NTs - changes in IS. Are individual investors (IS) who aggregate around CEFs and Small Stocks. CEFs D and Small stocks returns are correlated. arbitrage risky (not if it was constant): finite time horizon, risk of selling when D is high.
- Price increases at the end = the risk of selling at high D dissapears at announcement liquidation. NT risk eliminated! Small D at the end= TC arbitrage
5
Q
Implications CEF Puzzle
A
- Changes in D should be correlated across funds due to IS. They should all have D at the same time
- CEF are substitutes. Funds are clustered when D =low, meaning inv favor funds now
- IS must be systematic : small stocks also influenced by IIS should do well when D are low
