Volatility of closed-end fund discounts

Several financial puzzles surround the pricing of closed-end funds. The funds rarely trade at their net asset value (NAV), yet attempts to explain the characteristics of funds that lead to discounts or premiums have been largely unsuccessful. An important aspect of discounts that has received little attention is the nature of discount movements. Over short horizons of one to four weeks, discounts are actually much more volatile than NAVs. This paper makes use of a new data set of over 50,000 weekly discounts collected from the Wall Street Journal to investigate why discounts are so volatile. Eighty-nine stock, bond and international funds are analyzed. The primary questions addressed are: (1) Why are discounts highly volatile over short horizons? (2) Why are the discounts of some funds more volatile than those of others? (3) Are discount movements coordinated across funds? and (4) Do the economic factors that have been shown to explain portions of stock returns have explanatory power for discount movements?; The findings suggest that low liquidity for fund shares is the primary contributor to discount volatility over short horizons. There even appear to be small profit opportunities for traders willing to add liquidity to the market for CEF shares, while hedging their exposure to NAV movements. Funds with NAVs that are the easiest to hedge, and where CEF share turnover is the lowest tend to have the lowest discount volatilities.; Additional results show that funds of the same type (stock, bond or international funds) have discounts that move together. It is not clear why this discount co-movement occurs. The discount co-movements are not explained by the general sentiment of small investors (as proxied for by small-firm returns). Investor sentiment may yet be the explanation for discount co-movement among CEFs, but there would have to be three types of sentiment, one for stock funds, one for bond funds, and one for international funds.