Jeffrey Pontiff

Costly Arbitrage: Evidence from Closed-End Funds

Arbitrage costs lead to large deviations of prices from fundamentals. Using a sample of closed-end funds, I find that the market value of a fund is more likely to deviate from the value of its assets (1) for funds with portfolios that are difficult to replicate, (2) for funds that pay out smaller dividends, (3) for funds with lower market values, and (4) when interest rates are high. These factors are related to the magnitude of the deviation, as opposed to the direction (i.e., whether discount or premium), and explain a quarter of cross-sectional mispricing variation. These findings are consistent with noise trader models of asset pricing.

Book-to-market ratios as predictors of market returns

Abstract The book-to-market ratio of the Dow Jones Industrial Average predicts market returns and small firm excess returns over the period 1926–1994. The DJIA book-to-market ratio contains information about future returns that is not captured by other variables such as interest yield spreads and dividend yields. The DJIA book-to-market ratios predictive ability is specific to the pre-1960 sample. In contrast, the S&P book-to-market ratio provides some predictive ability in the post-1960 period, although this relation is dramatically weaker than the Dow Jones pre-1960 findings. The predictive ability of book-to-market ratios appears to stem from the relation between book value and future earnings.

Private benefits from block ownership and discounts on closed-end funds

The greater the managerial stock ownership in closed-end funds, the larger are the discounts to net asset value. The average discount for funds with blockholders is 14%, whereas the average discount for funds without blockholders is only 4%. This relation is robust over time and to various model specifications that control for other factors that affect discounts. We argue that blockholders receive private benefits that do not accrue to other shareholders and that they veto open-ending proposals to preserve these benefits. We support this argument by documenting a range of potential private benefits received by blockholders in closed-end funds.

Closed-end fund premia and returns Implications for financial market equilibrium

Abstract This paper examines the relation between closed-end fund premia and returns. Additional evidence is provided on Thompsons (1978) finding that fund premia are negatively correlated with future returns. Funds with 20% discounts have expected twelve-month returns that are 6% greater than nondiscounted funds. This correlation is attributed to premium mean-reversion, not to anticipated future portfolio performance. Economically motivated explanations do not account for this effect.

Reversions of Excess Pension Assets after Takeovers

This article evaluates pension asset reversions as a source of takeover gains. In our sample of 413 takeovers, pension funds were reverted by 15.1% of acquirers in the two years following hostile takeovers compared to 8.4% in the two years following friendly takeovers. Reversions following takeovers tend to occur in unit-benefit plans, where the potential for wealth transfer is the greatest. These results are consistent with the view that hostile takeovers breach implicit contracts between firms and employees. We estimate that the reversions can on average explain approximately 11% of the takeover premium in cases where they actually occur. Reversions are too small to be the sole, or even dominant, source of takeover gains.

Market Valuation of Tax-Timing Options: Evidence from Capital Gains Distributions

We examine a distribution that is taxed as a capital gain rather than as a dividend. Since the distribution induces a realized capital gain while the price change is an unrealized gain, ex-day return behavior provides evidence of the value of tax-timing capital gains. We show that investors are compensated 7¢ in unrealized gains for each dollar of realized capital gains, that is,

Investment Taxation and Portfolio Performance

1 of realized capital gains is equivalent to 93¢ of unrealized gains. An investor with a tax rate on realized gains of 15% has an effective tax rate on unrealized capital gains of 8.6%. Copyright 2006 by The American Finance Association.

Anomalies and News

We use the federal tax codes from 1926 through 2009 to construct the after-tax returns that individual investors, corporations, and broker–dealers would have generated on a set of benchmark portfolios. Portfolio strategies differ in the pace of capital gains realizations. This creates important heterogeneity in effective investment taxation beyond that implied by dividend yields. Tax burdens reduce the return premium that value portfolios earn over growth portfolios and the premium of small market capitalization portfolios over large market capitalization portfolios. Tax burdens exacerbate the equity premium puzzle, although they help explain mixed empirical results about the dividend preferences of high income and corporate investors.

A Closer Look at the Effects of Equity Market Liberalization in Emerging Markets

Using a sample of 97 stock return anomalies documented in published studies, we find that anomaly returns are 7 times higher on earnings announcement days and 2 times higher on corporate news days. The effects are similar on both the long and short sides, and they survive adjustments for risk exposure and data mining. Moreover, anomaly signals predict errors in analysts’ earnings forecasts — analysts’ forecasts are systematically too low for anomaly-longs and too high for anomaly-shorts. Taken together, our results support the view that anomaly returns are the result of biased expectations, which are at least partially corrected upon news arrival.

Hierarchies and the Survival of POWs during WWII

Previous studies link equity market liberalization to economic growth in emerging markets. In 24 emerging markets, liberalizations always coincide with other economic reforms, making identification tenuous. Theories linking liberalization to growth predict that at the firm-level liberalization leads to significant foreign ownership and influence on management, more external finance, and higher investment. We fail to find evidence that is consistent with any of these theories. Our findings suggest that either liberalization does not cause growth or that it promotes growth through a channel that is absent from the current literature.