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Investor Tax‐Trading Opportunities And Discounts On Closed‐End Mutual Funds

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  • Chang‐Soo Kim

Abstract

Discounts on closed‐end mutual funds are a puzzle to financial economists, because arbitrage activities should eliminate discounts in a perfect capital market. In this paper I develop a model that explains discounts, using Merton's option pricing theorem. By holding shares of a closed‐end mutual fund, investors lose valuable tax‐trading opportunities associated with the constituent securities of the closed‐end mutual fund's portfolio. However, investors can take advantage of all tax‐trading opportunities by directly holding the closed‐end mutual fund's portfolio. I also show that both variances of individual securities and correlations among securities in the portfolio are important factors in determining the magnitude of discounts.

Suggested Citation

  • Chang‐Soo Kim, 1994. "Investor Tax‐Trading Opportunities And Discounts On Closed‐End Mutual Funds," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 17(1), pages 65-75, March.
    • Handle: RePEc:bla:jfnres:v:17:y:1994:i:1:p:65-75
    DOI: 10.1111/j.1475-6803.1994.tb00174.x
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    Cited by:

    1. Kräussl, Roman & Pollet, Joshua & Stefanova, Denitsa, 2018. "Signaling or marketing? The role of discount control mechanisms in closed-end funds," CFS Working Paper Series 597, Center for Financial Studies (CFS).
    2. Jonathan Berk & Richard Stanton, 2004. "A Rational Model of the Closed-End Fund Discount," NBER Working Papers 10412, National Bureau of Economic Research, Inc.
    3. Mohamed Ayadi & Hatem Ben-Ameur & Skander Lazrak & Yue Wang, 2013. "Canadian Investors and the Discount on Closed-End Funds," Journal of Financial Services Research, Springer;Western Finance Association, vol. 43(1), pages 69-98, February.
    4. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    5. Cui, Yueting & Gebka, Bartosz & Kallinterakis, Vasileios, 2019. "Do closed-end fund investors herd?," Journal of Banking & Finance, Elsevier, vol. 105(C), pages 194-206.
    6. Stylianos X. Koufadakis, 2016. "Mispricing Explanations of Closed-End Funds: A Survey Review," SPOUDAI Journal of Economics and Business, SPOUDAI Journal of Economics and Business, University of Piraeus, vol. 66(1-2), pages 108-135, January-J.
    7. Chan, Kalok & Kot, Hung Wan & Li, Desmond, 2008. "Portfolio concentration and closed-end fund discounts: Evidence from the China market," Emerging Markets Review, Elsevier, vol. 9(2), pages 129-143, June.
    8. Lenkey, Stephen L., 2015. "The closed-end fund puzzle: Management fees and private information," Journal of Financial Intermediation, Elsevier, vol. 24(1), pages 112-129.
    9. repec:mth:ijafr8:v:9:y:2019:i:1:p:74-88 is not listed on IDEAS
    10. Kräussl, Roman & Pollet, Joshua M. & Stefanova, Denitsa, 2023. "Closed-end funds and discount control mechanisms," CFS Working Paper Series 707, Center for Financial Studies (CFS).
    11. Farhana Rahman, 2022. "Discount Puzzle Of Closed-End Mutual Funds: A Case Of Bangladesh," Papers 2209.13102, arXiv.org.
    12. Lahr, Henry & Kaserer, Christoph, 2009. "Net asset value discounts in listed private equity funds," CEFS Working Paper Series 2009-12, Technische Universität München (TUM), Center for Entrepreneurial and Financial Studies (CEFS).
    13. Reichert, Carolyn & Timmons, J. Douglas, 1998. "Closed-End Investment Companies: Historic Returns and Investment Strategies," Financial Services Review, Elsevier, vol. 7(2), pages 83-93.

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