Managerial Ability, Open-End Fund Flows, and Closed-End Fund Discounts

Abstract

I construct a dynamic rational expectations equilibrium model to unify open-end fund flows and closed-end fund discounts based on managerial ability. The model features both endogenous portfolio management of fund managers and endogenous fund purchase decisions of fund investors. The fully calibrated model matches many quantitative features of open-end fund flows and closed-end fund discounts. Furthermore, I propose a new economic theory to explain the convex flow-performance relationship, documented by previous empirical research on open-end fund flows. The proposed theory highlights the importance of incorporating active portfolio management into economic analysis of fund flows. Within the unified framework, the model predicts a convex premium-performance relationship when applied to closed-end funds. I empirically test and confirm this novel prediction.