Investor sentiment and the Closedend fund puzzle

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Investor sentiment and the Closedend fund puzzle

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Investor sentiment theory- discounts on closed-end funds ... Noise traders' sentiment is stochastic and cannot be perfectly forecasted by rational investors ... – PowerPoint PPT presentation

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Title: Investor sentiment and the Closedend fund puzzle


1
Investor sentiment and the Closed-end fund puzzle
  • Closed-end fund- issues a fixed number of shares
    that are traded on the stock marketshares 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.

2
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

3
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

4
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

5
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

6
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

7
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
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