Dylan C. Thomas

Noise Trading, Costly Arbitrage, and Asset Prices: Evidence from Closed-end Funds

If arbitrage is costly and noise traders are active, asset prices may deviate from fundamental values for long periods of time. We use a sample of 158 closed-end funds to show that noise-trader sentiment, as proxied by retail-investor flows, leads to fluctuations in the discount. Nevertheless, we reject the hypothesis that noise-trader risk is the cause of the long-run discount. Instead we find that funds which are more difficult to arbitrage have larger discounts, due to: (1) the censoring of the discount by the arbitrage bounds, and (2) the freedom of managers to increase charges when arbitrage is costly. Copyright The American Finance Association 2002.

Short-term reaction of stock markets in stressful circumstances

We document stock price behaviour in the period following a stock market stress. We focus on price behaviour using daily market indexes from 39 stock exchanges. Our results are not consistent with the overreaction hypothesis. We find positive (negative) abnormal price performance in the short-term windows (up to 10 days) following positive (negative) price shocks. The analysis also highlights some differences across markets classified as either developed and emerging. The post-shock abnormal performances are significantly larger for our sample of emerging markets. We find that the incidence of price shocks in both developed and emerging markets are not year- or month-dependent. In general, the quantitative impact of the after shock tremors is related to various measures of market liquidity. That is, the after shock price changes are stronger in illiquid markets. Major liquid markets behave in the same direction, but the post-shock price movements are milder. Finally, in many cases a cross market impact is identified. Its direction is usually from large markets to smaller ones. That is, extreme shocks in major markets are likely to impact strongly the price behavior in smaller markets.

The Impact of Corporate Governance on Closed-end Funds

This study uses a large sample of UK-listed closed-end funds to examine whether governance has an impact on two indicators of fund performance: the level of fund-management fees and the discount at which a fund trades. Fees are under the control of the directors, and we find that they are inversely related to fund returns, even after allowing for differences across investment sectors. Fees are, on average, higher if a fund has a large board, few directors from outside the fund-family, many directors from within the fund-family, and low ownership by the management company. Discounts for funds are wider if the management company or any blockholder has a significant long-term stake, suggesting that investors are wary of entrenched management. The results suggest that boards are frequently compromised in their duty to shareholders by their dependence on fund-management companies.

Investment trust IPOs: Issuing behaviour and price performance Evidence from the London Stock Exchange

Abstract In this paper, we document an average first day return of 1.91 percent for the population of 105 investment trust IPOs during the period from January 1984 through August 1992 on the London Stock Exchange. This is the first study that finds evidence of significant first day returns for a sample of closed-end fund IPOs. The results also suggest that investment trust IPOs are subject to ‘hot’ issue periods. These tend to occur when there is a marked narrowing in the discounts of seasoned investment trusts. Initial gains are, however, short lived; by the end of their first year, investment trust IPOs substantially underperform a number of relevant benchmarks and, on average, trade at discounts to their underlying net asset values.

The Cross-Sectional Variability of Stock-Price Returns: Country and Sector Effects Revisited

We investigate the impact of country and sector as variables in explaining the cross-sectional variability of price returns for a sample of over 1900 companies comprising the MSCI Developed World Index, drawn from 21 countries, over the period 1992-2001. For the value-weighted world portfolio, the country effect dominates although the sector effect increases markedly, and the country effect decreases, in the post-2000 period. The country effect is, however, much stronger when the largest 300 companies are excluded from the analysis. The same pattern is observed for the portfolio comprising companies from the EMU countries. For equally-weighted portfolios, the apparent dominance of the sector effect is largely attributable to the inclusion of the TMT sector. The negative trend in market-wide indices and the volatility experienced at the end of the sample period also account for the assertion that the sector effect has overtaken the country effect in the post-2000 period.

Warrants on the London Stock Exchange: Pricing Biases and Investor Confusion

This study of warrants on the London Stock Exchange examines whether they display particular pricing biases and whether investors understand how to value them at the time of issue. In a sample of 72 warrants on closed-end funds (investment trusts) over the 1985–94 period, more than one third of the 12,673 prices are anomalously low. The other two thirds behave like stock options, with lower volatility when they are in-the-money or have a long time until maturity. Despite their frequent undervaluation, it is rational to add warrants to a new equity issue. An examination of 127 new equity issues (95 with warrants) reveals that attaching warrants significantly increases market value. The reason for this appears to be investor confusion: they do not seem to understand that the more the warrants are worth, the less the value of the ordinary shares.

The short-term impact of director trading in UK closed-end funds

Most closed-end funds are transparent entities that hold securities that are actively traded in liquid markets. In such a setting, the argument that director transactions mitigate information asymmetry has very limited applicability. Our results provide support for the theory of Barber and Odean [2008. “All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors.” Review of Financial Studies 21: 785–818]: retail investor decision-making is influenced by attention-grabbing events. Director purchases are one such attention-grabbing event and are associated with significant positive price returns – the magnitudes of which are linked to the size of the purchase, the size of the fund, and the investment mandate. Trading volumes increase at the time of the purchase but most of the initial price responses and trading volumes dissipate over the following 15 days.

Country Funds and Investor Sentiment: U.K. and U.S. Evidence

This article provides support for the notion of investor sentiment using the population of U.K.- and U.S.-traded closed-end country funds. Despite the different shareholder profiles, we find marked similarities in the timing of U.K./U.S. country fund IPOs and in the pricing structure of U.K.- and U.S.-traded funds. Using U.K. data, we document strong evidence of a robust relation between individual-investor money flowing into U.K. mutual funds and a narrowing in the discount of U.K.-traded country funds. There is no evidence of a link between the level of the discount and institutional investor activity.

Fund Mortality and Fair Discounts on Closed-End Funds

We develop and test a rational model of discounts that takes account of conditional expectations about fund lives. Previous research has assumed that lives are very long, implying unrealistically large discounts. We find that expected lives are short: 10 years or less up to the age of five, then rising slowly to a plateau of 18 years. If dividends are paid, weighted-average lives are even shorter. The model is calibrated to the first 20 years of a fund’s life and tested with cross-section data from the UK and US. We conclude that life-expectancy plays a central role in explaining discounts, but it is not sufficient (by itself) to explain the premia on new issues.