Investor Demand for Leverage: Evidence from Equity Closed-End Funds and and the Launch of Levered Exchange-Traded Funds
47 Pages Posted: 6 Nov 2018 Last revised: 20 Nov 2019
Date Written: November 19, 2019
We provide novel evidence that investor demand for leverage is both a causal and significant driver of equity closed-end fund (CEF) discounts. More levered funds trade at smaller discounts, despite having worse performance. The relation is not consistent with any rational story considered. We use the introduction of levered exchange-traded funds (ETFs) as a plausibly exogenous shock to establish causality. The discount on levered CEFs increases by 2.3 percentage points (an increase of 32%), despite their relative performance improvements after the entry of this new competition. Our results help explain the leverage puzzle in the cross section of returns and also provide new insights for studies that rely on CEF discounts as a measure of investor sentiment.
Keywords: Investor sentiment, leverage, levered closed-end fund, levered exchange-traded fund, non-fundamental demand
JEL Classification: G12, G14
Suggested Citation: Suggested Citation