Risk and Return in Trading Closed-End Country Funds: Can Trading Beat Holding Foreign Stocks?
QUARTERLY REVIEW OF ECONOMICS AND FINANCE, Vol. 36 No. 2, Summer 1996
Posted: 10 Oct 1996
The discounts of closed-end country funds, from their net asset value, vary substantially from week to week. Statistical tests in this paper indicate that these discounts are mean reverting and therefore the discount has a predictable component. We investigate whether additional returns can be gained from a strategy of switching from equities into the closed-end funds when the discount is large and selling the fund and rebuying equities when the discount narrows.Because only limited data exists for closed-end country funds, we use Monte Carlo simulations to calculate the expected returns from the strategy. These simulations show that substantial profits, over and above the returns on the portfolio of foreign stocks held by the fund, can be earned.One drawback to investing in these country funds is that their prices tend to be more highly correlated with the US market than their portfolios are. We estimate the relevant betas and compute the additional returns necessary to compensate the investor for the additional systematic risk. After netting out the risk compensation, substantial abnormal returns remain.
JEL Classification: C15, G15
Suggested Citation: Suggested Citation