Valuation scepticism, liquidity benefits and closed‐end fund premiums/discounts: evidence from fair value disclosures

Abstract

Closed-end fund investors may view assets valued using level 2 and 3 inputs more sceptically because of the subjectivity of these inputs (valuation scepticism), or these assets could be viewed favourably because they allow small investors to access illiquid securities (liquidity benefit). We find that funds holding level 3 assets have higher value when funds trade at a premium, but lower value when funds trade at a discount. Both of these effects are magnified for funds with higher levels of unrealized appreciation. Our results suggest that liquidity benefit (valuation scepticism) is more important when funds trade at a premium (discount).

Nonlinear Dynamics Characteristic of Risk Contagion in Financial Market Based on Agent Modeling and Complex Network

“…And in some cases, rational traders likely turned into noise traders [27]. On the basis of the hypothesis of bounded rationality, the more researches explained risk contagion in financial markets from the perspective of investor behavior bias, such as equity premium puzzle [28][29][30], idiosyncratic volatility puzzle [31][32][33], closed-end fund puzzle [34][35][36], and dividend puzzle [37][38][39]. In addition, the cognitive bias and irrational behavior of investors were often associated with overconfidence theory.…”

Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on PCAOB Staff Consultation Paper, Auditing Accounting Estimates and Fair Value Measurements

“…Given this increased disclosure requirement, and the fact that the market discounts Level 3 securities more than Level 2 securities, companies have incentives to use a Level 2 over a Level 3 classification to avoid being punished by the market (e.g., Laux and Leuz 2009;Laux and Leuz 2010). For example, studies find that Level 3 assets have greater information asymmetry when compared to Level 2 assets (Riedl and Serafeim 2011), the market discounts Level 3 securities significantly more than Level 2 securities (e.g., Beck 2012; Cullinan and Zheng 2014;Song, Thomas, and Yi 2010;Kolev 2009), and that the discount observed for Level 3 securities ranges from 20 to 30 percent of reported assets (Laux and Leuz 2010). Because fair value classification is important to investors, auditors dedicate significant effort in conducting ASC 820 ''leveling'' procedures 1 to evaluate the appropriateness of management's classifications.…”

Injecting liquidity into liquidity research

“…They find that there is no strong evidence to support the use of emulation funds from a cost-benefit perspective in the Australian environment. Cullinan and Zheng (2014) examine the effect of liquidity on closed-end fund discounts and find that liquidity is more important when these funds trade at a premium.…”