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Closed‐end funds and sentiment risk

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  • Alan K. Severn

Abstract

Irradional noise traders earn high returns for bearing risk that they themselves create. Diversifying across closed‐end funds does little to reduce this risk, because discounts are correlated across funds. But diversification between closed‐end funds and large‐cap stocks does reduce this risk, especially when markets are not subject to major shocks: a combination of closed‐end funds and large‐cap stocks has lower risk than either one alone. To the extent that fund shares and large‐cap stocks are partially segmented markets, large‐cap stocks thus provide some protection against the sentiment risk created by noise traders. This paper estimates the amount of large‐cap stocks needed in tax‐deferred portfolios, under various amounts of market‐wide risk, and ways of measuring it.

Suggested Citation

  • Alan K. Severn, 1998. "Closed‐end funds and sentiment risk," Review of Financial Economics, John Wiley & Sons, vol. 7(1), pages 103-119.
    • Handle: RePEc:wly:revfec:v:7:y:1998:i:1:p:103-119
    DOI: 10.1016/S1058-3300(99)80148-7
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    References listed on IDEAS

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