Short Selling and the Pricing of Closed-End Funds

Abstract

In contrast to the perception that short sellers avoid closed-end funds, we find a significant amount of short selling in such funds during our sample period of January 2005 to March 2007. Short sellers of closed-end funds have short horizons, maintaining their positions for an average of seven days. While they are more active in funds that trade at a premium to net asset value, they are surprisingly active in funds that sell at a discount. Short sellers increase their activities significantly during, as well as immediately after, increases in fund premiums and decreases in discounts. Premiums decline and discounts increase following increases in short selling. Short selling over the current day and the previous five days explains 60% of the variance in the change in premiums over the subsequent five days. We conclude that short selling contributes to mean reversion in both premiums and discounts, and that these results are consistent with models such as Ross (2002) that suggest closed-end funds can have equilibrium prices that vary cross-sectionally, with some being below their NAVs while others are above their NAVs.