Abstract
This article presents a mathematical model for explaining the premiums and discounts to net asset value for closed-end funds. The model does not require (1) constraining assumptions about the underlying price, liquidity, and volatility paths of securities held in the funds, or (2) differential market knowledge between fund investors and fund managers. Our empirical tests show that the observed discounts and premiums for seasoned U.S. closed-end funds are consistent with the model’s explicit predictions regarding payout policy and the relative performance of underlying fund holdings. Consistent with the implicit predictions of the model, our results show that fund size, sentiment, and liquidity also affect how a closed-end fund trades.
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