Canadian investors and the discount on closed-end funds
Abstract
Small investors' sentiment has been proposed by behaviouralists to explain the
existence and behavior of discount on closed-end funds (CEFD). The empirical tests
of this sentiment hypothesis so far provide equivocal results. Besides, most of
out-of-sample tests outside U.S. are not robust in the sense that they fail to well
control other firm characteristics and risk factors that may explain stock return and to
provide a formal cross-sectional test of the link between CEFD and stock return. This
thesis explores the role of CEFD in asset pricing and further validates CEFD as a
sentiment proxy in Canadian context and augments the extant studies by examining
the redemption feature inherent in Canadian closed-end funds and by enhancing the
robustness of the empirical tests. Our empirical results document differential
behaviors in discounts between redeemable funds and non-redeemable funds.
However, we don't find supportive evidence of CEFD as a priced factor. Specifically,
the stocks with different exposures to CEFD fail to provide significantly different
average return. Nor does CEFD provide significant incremental explanatory power,
after controlling other well-known firm characteristics and risk factors, in
cross-sectional as well as time-series variation of stock return. This evidence, together
with the findings from our direct test of CEFD as a sentiment index, suggests that
CEFD, even the discount on traditional non-redeemable closed-end funds, is unlikely
to be driven by elusive sentiment in Canada.