Risk and Income Effects on Closed-End Funds Using Derived CAPM Valuation Model

Abstract

There have been many theories developed to explain the discount that existed for closed end funds. But few valuation models for closed end funds were ever developed. In this paper, a valuation model for closed-end fund is derived using the CAPM, which may be considered a breakthrough in the field of closed-end funds since a formula for estimating the theoretical value of the fund portfolio has been developed without a priori knowledge of its beta value, the need for making constant growth assumption, or resorting to regression analysis which is subject to statistical error. Based on this model, we calculate the expected return of the fund portfolio as implied by the actual discount (implied return) for 35 general closed end funds. We found that high discount corresponds with low implied return. More interestingly, high discount is found to correspond significantly with low expected net return, where expected net return is implied return in excess of expense ratio.