THE FUNDAMENTAL THEOREMS OF ASSET PRICING AND THE CLOSED-END FUND PUZZLE

Gabriel Frahm, Alexander Jonen () and Rainer Schüssler ()
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Gabriel Frahm: Department of Mathematics and Statistics, Helmut Schmidt University, Holstenhofweg 85, D-22043 Hamburg, Germany
Alexander Jonen: Department of Mathematics and Statistics, Helmut Schmidt University, Holstenhofweg 85, D-22043 Hamburg, Germany
Rainer Schüssler: #x2020;Department of Economics, University of Rostock, Ulmenstraße 69, D-18057 Rostock, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2019, vol. 22, issue 05, 1-31

Abstract: We propose a solution to the closed-end fund puzzle in financial markets without a free lunch with vanishing risk. Our results are consistent with both the time-series and the cross-sectional aspect of the closed-end fund puzzle. It turns out that a closed-end fund cannot exist if the fund manager is supposed to receive a fee although he is not able to find mispriced assets in the market. By contrast, a premium can typically be observed at the initial public offering because the fund manager has access to information that enables him to create a dominant strategy. As soon as this weak arbitrage opportunity evaporates, a premium can no longer occur. The reason why a premium quickly turns into a discount might be that the fund manager stops applying a superior trading strategy at some point in time. Another possibility is that abnormal profits are transient in a competitive financial market. In any case, when the fund manager is no longer willing or able to maintain a superior strategy, the fund must trade at a discount in order to compensate for his management fee.

Keywords: Admissibility; closed-end fund puzzle; discount; fundamental theorem of asset pricing; maximal strategy; net asset value; no arbitrage; premium (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1142/S0219024919500250

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