Abstract
We provide evidence that redemption risk undermines managerial incentives to trade against mispricing. We start by comparing open-end funds with closed-end funds, which are similarly regulated, but not subject to redemptions. Compared to open-end funds, closed-end funds purchase more underpriced stocks, especially if these involve high arbitrage risk. We then extend the analysis to prototypical rational arbitrageurs, hedge funds. Hedge funds with higher share restrictions are also more likely to trade against mispricing than other hedge funds. Thus, organizational structures involving less redemption risk appear to better serve the social function of bringing prices to their fundamental values.
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