Dividend Habitants and the Closed-End Fund Puzzle

Abstract

I hypothesize that income-oriented investors, who prioritize stable income from their portfolios, condition on a fund's dividend history when assessing the riskiness of future payouts. Consistent with this view, I develop a theoretical framework in which past distribution patterns are informative about cash flow variance and thus affect the pricing of closed-end funds (CEFs). Confirming empirical evidence shows that CEFs with histories of dividend cuts, high variability in distributions, and infrequent payments trade at significantly deeper discounts to net asset value than those characterized by dividend increases, greater stability, and more frequent distributions. These results offer a novel explanation for the long-standing closed-end fund puzzle. Importantly, dividend yields explain more variation in discount rates once past distributions are taken into account, indicating that income investors weigh dividend history alongside current yields.

Keywords: Dividends, Closed-End Fund Puzzle, Income Investors, Clientele Effects, Income Risk, Signaling, Valuation, Extrapolation

JEL Classification: G11, G12, G14, G23, G41