Illiquidity and Closed-End Country Fund Discounts

Ravi Jain, Yihong Xia and Matthew Qianli Wu
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Ravi Jain: Temple U
Matthew Qianli Wu: U of Pennsylvania

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: In a simple model of segmented markets and exogenous liquidity shock, the closed-end country fund premium is negatively affected by the illiquidity in the host market where shares of the country fund are traded, and positively affected by the illiquidity in the home market where the underlying assets are traded. To the extent that expected and unexpected liquidity affects asset prices and returns, the closed-end country fund premium should reflect the difference between the illiquidity of the fund shares and its underlying assets. Using the Amihud (2002) measure of illiquidity, we examine this hypothesis for U.S.-traded single country closed-end funds, and find a strong association between the fund premium and the illiquidity of both the host and the home markets. Moreover, this relation is much stronger for funds investing in emerging markets where market segmentation is more likely to be binding. These funds are also more sensitive to the systematic liquidity factor, suggesting that the country fund premium may contain a significant liquidity risk premium.

Date: 2004-06
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