Trend Breaks and the Persistence of Closed-End Mutual Fund Discounts

Durmaz, Nazif and Kim, Hyeongwoo and Lee, Hyejin and Sun, Yanfei (2023): Trend Breaks and the Persistence of Closed-End Mutual Fund Discounts.

Abstract

Closed-end fund (CEF) prices often exhibit large and persistent deviations from their associated net asset values (NAVs), which is puzzling considering that NAVs are publicly observable for CEFs, which essentially represent repackaged financial assets. The persistence of these deviations is particularly notable when using linear models, suggesting the need for nonlinear models to comprehend this phenomenon known as the CEF discount puzzle. To unravel this puzzle, we employ the RALS-LM framework, enabling the identification of multiple endogenously chosen trend-breaks, and conduct an analysis utilizing data from 31 CEF discounts. Our findings reveal that CEF prices tend to fluctuate around time-varying trends, which aligns with the characteristics of regime switching models. Additionally, we demonstrate that incorporating non-normal errors through moment conditions enhances efficiency at the margin. Moreover, we establish that nonlinearity solely in the form of level shifts falls short in explaining the persistent nature of CEF discounts.

• Item Type: MPRA Paper
• Language: English
• Keywords: Closed-End Fund; CEF Discount Puzzle; Residual Augmented Least Squares; Non-Normal Error; Trend Breaks
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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