Working Paper: NBER ID: w10412
Authors: Jonathan Berk; Richard Stanton
Abstract: The discount on closed-end funds is widely accepted as proof of investor irrationality. We show,however, that a parsimonious rational model can generate a discount that exhibits many of the characteristics observed in practice. The only required features of the model are that managers have (imperfectly observable) ability to generate excess returns; they sign long-term contracts guaranteeing them a fee each year equal to a fixed fraction of assets under management; and they can leave to earn more money elsewhere if they turn out to be good. With these assumptions, time-varying discounts are not an anomaly in a rational world with competitive investors -- they are required.
Keywords: closed-end funds; discount; investor behavior; managerial ability; rational model
JEL Codes: G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| managerial ability (M54) | fund performance (G14) |
| fund performance (G14) | fund discount relative to NAV (G23) |
| managerial ability (M54) | fund discount relative to NAV (G23) |
| management fees (G19) | investor perceptions of fund value (G11) |
| investor perceptions of fund value (G11) | fund discount relative to NAV (G23) |
| managerial ability (M54) | expected discount (H43) |
| manager's tenure (M51) | expected discount (H43) |
| managerial ability (M54) | premium or discount (E43) |
| fund discount (G23) | NAV convergence (Y10) |