The Persistence and Predictability of Closed-End Fund Discounts

40 Pages Posted: 21 Mar 2005

See all articles by Burton G. Malkiel

Burton G. Malkiel

Princeton University - Bendheim Center for Finance; National Bureau of Economic Research (NBER)

Yexiao Xu

University of Texas at Dallas - School of Management

Date Written: March 2005

Abstract

It is well-known that the level of closed-end fund discounts appears to predict the corresponding fund's future returns. We further document that such predictability decays slowly. The popular explanations, including the tax effect, investor sentiment risk, and the funds's dividend yield, do not fully account for the observed predictability. At the same time, discounts are very persistent especially on an aggregate level. Using an AR(1) model for discounts, we demonstrate that such predictability is largely due to persistence in discounts. Our calibration exercise can produce most characteristics of an aggregate equity close-end fund index over the ten year period from 1993 to 2001. A cross-sectional study links discount persistence to rational factors such as dividend yield, unrealized capital gains, and turnover. In addition, we document a second independent source for predicting fund returns from large stock portfolio returns. This suggests that the well-known lead lag relationship between large stocks and small stocks also exists between NAV returns and fund returns. Finally, we find no evidence for "excess volatility" on the aggregate level both for conditional and unconditional volatility.

Keywords: closed-end fund, cross-correlation, discount, excess volatility, investor sentiment, large stocks, persistence, small stocks, turnover

JEL Classification: G12, G14, G19

Suggested Citation

Malkiel, Burton G. and Xu, Yexiao, The Persistence and Predictability of Closed-End Fund Discounts (March 2005). Available at SSRN: https://ssrn.com/abstract=686981 or http://dx.doi.org/10.2139/ssrn.686981

Burton G. Malkiel

Princeton University - Bendheim Center for Finance ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States
609-258-6445 (Phone)
609-258-0771 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yexiao Xu (Contact Author)

University of Texas at Dallas - School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States
972-883-6703 (Phone)

HOME PAGE: http://www.utdallas.edu/~yexiaoxu

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