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Investor sentiment and the Closed-end fund puzzle Closed-end fund- issues a fixed number of shares that are traded on the stock market;shares are liquidated by selling the shares to other investors.

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investor sentiment and the closed end fund puzzle
Investor sentiment and the Closed-end fund puzzle
  • Closed-end fund- issues a fixed number of shares that are traded on the stock market;shares are liquidated by selling the shares to other investors.
  • Closed-end fund puzzle- they typically sell at prices not equal to the per share market value of assets the fund holds.
possible reasons for discount prices of closed end fund shares
Possible reasons for discount prices of closed-end fund shares
  • Agency costs
  • Tax liabilities
  • Illiquidity of assets
  • Investor sentiment theory- discounts on closed-end funds reflect expectations of individual investors
four pieces of the puzzle
Four pieces of the puzzle
  • Closed-end funds start out at a premium
  • Although they start at a premium, the funds sell at a discount within 120 days
  • Discounts on closed-end funds are subject to wide fluctuations over time
  • On termination through a liquidation or open trading, share prices of the funds rise and discounts shrink
investor sentiment theory
Investor sentiment theory
  • DSSW present a model of asset pricing based on the idea that the unpredictability of the opinions of not fully rational investors impounds resale price risk on the assets they trade.
  • Assumptions made by DSSW:
  • Rational investors' horizons are short
  • Noise traders’ sentiment is stochastic and cannot be perfectly forecasted by rational investors

Other elements:

-Different clienteles

-Noise traders are more likely to hold closed-end funds than assets in funds’ portfolios

investor sentiment and the 4 part puzzle
Investor sentiment and the 4 part puzzle
  • Closed-end funds sell at a discount-due to risk in holding a fund over its portfolio
  • Investors buy fund shares at a premium-
  • Discounts on closed end-funds experience wide fluctuations-due to changes in investor sentiments about future returns
  • On termination of fund, share prices rise due to elimination of noise trader risk
predictions of investor sentiment model
Predictions of investor sentiment model
  • Discounts on closed-end funds will be correlated
  • New funds get started when old funds sell at a premium
  • Discounts on closed-end funds narrow when smaller stocks do well
conclusion
Conclusion
  • Closed-end fund discounts are a measure of the sentiment of individual investors.
  • This sentiment is sufficiently widespread to affect the prices of smaller stocks in the same way it affects closed-end fund prices