MARKET INEFFICIENCIES IN THE PRICING OF LOAN PARTICIPATION CLOSED-END FUNDS

Daniel A. Crowley, Donald Chambers, Department of Economics, Lafayette College, 730 High St, Easton, PA 18042

This study analyzes the extent to which loan participation closed-end Funds are priced efficiently. Closed-end Funds (CEFs) are publicly traded mutual Funds that raise capital from issuing shares and invest the capital in financial securities. Unlike open-end mutual Funds, closed-end shares cannot be sold back to the Fund. Instead, shares are traded on a secondary market. The shares trade at market values, which often differs from the market values of the Fund’s underlying portfolio. The percent difference between the share price and the net asset value (NAV) is known as the premium or, if negative, the discount. The existence of CEF discounts appears to violate a fundamental principle in microeconomics, which questions the informational efficiency of financial markets. I add to the existing literature by focusing on one subset of Funds, loan participation CEFs (LPCEF). Many characteristics of these neglected LPCEFs, such as the illiquidity of loans, are potential rational motivations for discounts. The study is broken into two sections of analysis of discount behavior: cross-sectional and time series. First, I build a rational pricing model based on fees, asset allocation and substitutes. The regression results do not explain significant variation in the discounts and potentially indicate that LPCEFs are not efficiently priced. I then statistically evaluate the investor sentiment theory to identify pricing inefficiency. Using unit-root tests and ARCH based methodologies, I test for stationarity and predictability in the discounts. The tested hypothesis is that the sample is mean reverting and thus inefficiently priced. This analysis contributes to the ongoing debate on the motivation and persistence of CEF discounts and the more general debate on the rationality of individual investors. While there is extensive academic literature on the CEF discounts, there is no previous research on the LPCEF sample.


Additional Abstract Information

Presenter: Daniel Crowley

Institution: Lafayette College

Type: Oral

Subject: Economics

Status: Approved


Time and Location

Session: Oral 9
Date/Time: Fri 4:20pm-4:40pm
Location: Fogelman Classroom Building 127
List other presenters in this same room and session