A rational asset pricing model for premiums and discounts on closed‐end funds: The bubble theory

Abstract

This paper provides a new explanation for closed‐end fund (CEF) discounts and premiums using the local martingale theory of asset price bubbles. This is a rational asset pricing model that is shown to be consistent with the existing empirical evidence on CEF discounts/premiums. Additional testable implications of the model are derived, which await subsequent research for their resolution. This bubble theory also applies equally well to understanding discounts and premiums on exchange traded funds.

Evaluating the performance of U.S. international equity closed-end funds

“…The CEF portfolios are substantially more volatile than the benchmark assets. The higher volatility of the CEF is consistent with Pontiff(1997) (see also Jarrow and Protter(2019)). The Global/Europe portfolio has the lowest volatility, and the EM portfolio has the highest volatility.…”

“…CEF performance using stock returns depends upon a number of factors such as the performance ability of the fund managers, trading costs and expenses, and the CEF discount/premium. Rational explanations of the CEF discount includes Berk and Stanton(2007), Cherkes et al(2009), and Jarrow and Protter(2019).…”

Trend Breaks and the Persistence of Closed-End Mutual Fund Discounts

“…3 See, among others, Thaler (1990, 1991), Ahmed, Koppl, Rosser, and White (1997), Gemmill and Thomas (2002), Hughen and Wohar (2006), and Berk and Stanton (2007) who have shed light on the factors and mechanisms that contribute to the observed discounts and premiums in CEFs. 4 Many researchers put forward theoretical hypotheses for such puzzling phenomena of the CEF Puzzle, such as investor sentiment (De Long, Shleifer, Summers, and Waldmann, 1990;Lee et al, 1991;Chopra, Lee, Shleifer, and Thaler, 1993;Anderson, Beard, Kim, and Stern, 2013); arbitrage costs (Pontiff, 1996;Gemmill and Thomas, 2002); accumulated tax liability effects (Malkiel, 1995;Day, Li, and Xu, 2011); the structure of management fees and compensation (Ross, 2002;Berk and Stanton, 2007); and asset price bubbles (Jarrow and Protter, 2019). These theoretical hypotheses represent different perspectives on the underlying drivers of the CEF puzzle, aiming to provide a comprehensive understanding of this intriguing phenomenon.…”