A Liquidity-Based Theory of Closed-End Funds

Posted: 3 Jan 2009

See all articles by Martin Cherkes

Martin Cherkes

NYU

Jacob S. Sagi

University of North Carolina Kenan-Flagler Business School

Richard Stanton

University of California, Berkeley - Haas School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: January 2009

Abstract

This paper develops a rational, liquidity-based model of closed-end funds (CEFs) that provides an economic motivation for the existence of this organizational form: They offer a means for investors to buy illiquid securities, without facing the potential costs associated with direct trading and without the externalities imposed by an open-end fund structure. Our theory predicts the patterns observed in CEF initial public offerings (IPOs) and the observed behavior of the CEF discount, which results from a trade-off between the liquidity benefits of investing in the CEF and the fees charged by the fund's managers. In particular, the model explains why IPOs occur in waves in certain sectors at a time, why funds are issued at a premium to net asset value (NAV), and why they later usually trade at a discount. We also conduct an empirical investigation, which, overall, provides more support for a liquidity-based model than for an alternative sentiment-based explanation.

Keywords: G14

Suggested Citation

Cherkes, Martin and Sagi, Jacob and Stanton, Richard H., A Liquidity-Based Theory of Closed-End Funds (January 2009). The Review of Financial Studies, Vol. 22, Issue 1, pp. 257-297, 2009. Available at SSRN: https://ssrn.com/abstract=1320557 or http://dx.doi.org/hhn028

Martin Cherkes (Contact Author)

NYU ( email )

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Jacob Sagi

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

HOME PAGE: http://public.kenan-flagler.unc.edu/faculty/sagij/

Richard H. Stanton

University of California, Berkeley - Haas School of Business ( email )

Haas School of Business
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Berkeley, CA 94720-1900
United States
(510) 642-7382 (Phone)
(510) 643-1412 (Fax)

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