Closed-end funds and emerging capital markets

This paper is concerned with portfolio investments to emerging markets in the specific form of closed-end funds. Previous studies have reported that closed-end funds present several puzzles in their pricing behavior. Ishak Diwan, Lemma Senbet and Vihang Errunza studied many of these phenomenon in several research papers. They developed a model (DES model) and concluded that premiums or discounts on country specific funds depend on expected cash flows, degree of access to the market by foreign investors, the correlation between domestic and foreign markets and the degree of substitution between the closed-end funds and underlying assets.;The DES model is subject to weaknesses on the empirical side in that it does not incorporate testable variables for the expected cash flows and uses dummy variables for the degree of access to the market by foreign investors. Nevertheless, the model serves as the beginning point of this paper. The DES model is strengthened by adding several new variables and testing the influence of direct and indirect barriers to investments and the impact of expected cash flows. Significant results are found for several of them, such as ranking of countries according to quantity and quality of market information, and an index based on relative value of direct barriers to portfolio investments across the countries.;During the past decade capital flows to the emerging markets have increased sharply. However, short-term capital flows, which are not normally connected with direct investment, are often particularly destabilizing. Since closed-end funds have certain advantages for developing economies, including the inherently long-term nature of their investments, this paper concludes with a proposal for Russia and interested parties to establish a Russian Fund(s). A case is made for the development of closed-end funds in Russia and other transforming economies.