A Rational Model of the Closed-End Fund Discount

30 Pages Posted: 20 Apr 2004

See all articles by Jonathan Berk

Jonathan Berk

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Richard Stanton

University of California, Berkeley - Haas School of Business

Date Written: April 2004

Abstract

The discount on closed-end funds is widely accepted as proof of investor irrationality. We show,however, that a parsimonious rational model can generate a discount that exhibits many of the characteristics observed in practice. The only required features of the model are that managers have (imperfectly observable) ability to generate excess returns; they sign long-term contracts guaranteeing them a fee each year equal to a fixed fraction of assets under management; and they can leave to earn more money elsewhere if they turn out to be good. With these assumptions, time-varying discounts are not an anomaly in a rational world with competitive investors -- they are required.

Suggested Citation

Berk, Jonathan B. and Stanton, Richard H., A Rational Model of the Closed-End Fund Discount (April 2004). NBER Working Paper No. w10412. Available at SSRN: https://ssrn.com/abstract=528993

Jonathan B. Berk (Contact Author)

Stanford Graduate School of Business ( email )

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National Bureau of Economic Research (NBER)

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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
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(510) 643-1412 (Fax)

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