The Design and Pricing of Country Funds Under Market Segmentation

Posted: 8 Jan 2001

See all articles by Cheol S. Eun

Cheol S. Eun

Georgia Institute of Technology - Finance Area

S. Janakiramanan

National University of Singapore (NUS) - NUS Business School

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business

Date Written: November 1993

Abstract

This paper provides an analysis of the design and pricing of closed-end country funds (CECFs) under segmented capital markets, where an investment company acquires a set of eligible securities from the home country to form a CECF and issues shares to the residents of the host country. The key findings are: First, a country fund will trade at its net asset value (zero premium), effectively as an open-end, if the fund acquires as much of eligible securities as the differential 'substitution' demand for them between the host and home country investors. Under the open-ending design rule, the implied premium will also be zero for all eligible securities. Second, the fund will command a higher premium, the more (less) close a substitute the fund is for the market portfolio of the home (host) country, and the more (less) risk-averse the home (host) country investors are collectively. Third, the optimal design rule for a profit- maximizing intermediary, which creates and markets the fund, calls for investing heavily in those eligible securities that covary most with the market portfolio of the home country and least with that of the host country. In our framework, the (monopolistic) intermediary can actually maximize its profit by acquiring just half as much of eligible securities as are necessary to effectively open-end the fund, due to the quadratic nature of the fund premium function.

JEL Classification: G12, G15

Suggested Citation

Eun, Cheol S. and Janakiramanan, S. and Senbet, Lemma W., The Design and Pricing of Country Funds Under Market Segmentation (November 1993). Available at SSRN: https://ssrn.com/abstract=5721

Cheol S. Eun

Georgia Institute of Technology - Finance Area ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

S. Janakiramanan

National University of Singapore (NUS) - NUS Business School

1 Business Link
Singapore, 117592
Republic of Singapore

Lemma W. Senbet (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2242 (Phone)
301-405-0359 (Fax)

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