Investor Demand for Leverage: Evidence from Equity Closed-End Funds

Abstract

We provide evidence that investors with leverage constraints demand leverage, for the sake of leverage. We study the equity closed-end fund (CEF) market and document a strong negative relation between fund leverage and CEF discounts, indicating that investors pay a relative premium for leverage. We show that leverage changes do not signal improved fund performance. Instead, the only benefit to investors of increased leverage is amplified exposure via greater volatility and risk exposure. We utilize a quasi-natural experiment to identify leverage as a causal driver of demand and provide external validity by relating our results to the betting-against-beta factor.

Keywords: Leverage constraints, leverage, closed-end funds

JEL Classification: G12, G14, G32