Costly Arbitrage and the Closed-End Fund Puzzle: Evidence from a Natural Experiment
39 Pages Posted: 23 Jun 2015 Last revised: 11 May 2016
Date Written: May 10, 2016
We examine how short sale constraints on portfolio holdings affect closed-end fund (CEF) discounts and thereby distinguish behavioral-based explanations from fundamental-based explanations of the discounts. Using Regulation SHO as a natural experiment that relaxes short-sale constraints on pilot stocks, we find that discounts of CEFs holding more pilot stocks decrease relative to CEFs holding fewer pilot stocks. We also find that the effect comes only from CEFs that trade at discounts. The results suggest that a substantial part of CEF discounts is driven by mispricing.
Keywords: Costly Arbitrage, Mispricing, Closed-End Fund Puzzle, Short Sale Constraints, Regulation SHO
JEL Classification: G12, G18
Suggested Citation: Suggested Citation