Incomplete information and the closed-end fund discount
- Barone-Adesi, Giovanni Istituto di finanza (IFin), Facoltà di scienze economiche, Università della Svizzera italiana, Svizzera
- Kim, Youngsoo Faculty of Business, University of Alberta, Edmonton-Alberta, Canada
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1999
22 p.
English
We model the closed-end fund discount/premium in a version of Merton’s (1978) asset pricing model with incomplete information. In this economy, investors trade only assets which they “know about”. The model generates a closed-end fund discount or premium, depending on risk-aversion parameters. The fund share price reverts to the net asset value on open-ending of the fund. The discount/premium is a result of two economic forces: (1) the fund manager’s objective is to maximize expected utility of her fee income rather than the welfare of fund shareholders. Mis-alignment of objectives of the fund manager and shareholders results in discount/premium, and (2) for given risk aversion parameters, diversification benefits to investors determine the size of the discount/premium. Pontiff (1996) documents a positive relation between discounts and unhedgeable risk. This evidence along with other findings leads Pontiff to conclude that discounts appear to be a result of mispricing. Our model provides an alternative interpretation on the positive relation found by Pontiff based on the economic forces depicted above.
- Language
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- English
- Classification
- Economics
- License
- License undefined
- Identifiers
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- RERO DOC 9084
- ARK ark:/12658/srd1317968
- Persistent URL
- https://n2t.net/ark:/12658/srd1317968
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