Recent Turmoil in Emerging Markets and the Behavior of Country-Fund Discounts: Renewing the Puzzle of the Pricing of Closed-End Mutual Funds
IMF Working Papers, July 1, 1995
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- Recent Turmoil in Emerging Markets and the Behavior of Country-Fund Discounts: Renewing the Puzzle of the Pricing of Closed-End Mutual Funds
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Bibliographic details
- Authors: Charles Frederick Kramer, T. Todd Smith
- Published: July 1, 1995
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451848953.001
Core findings
- Closed-end funds dedicated to Mexico and other Latin American stock markets developed large premia after the December 1994 devaluation of the Mexican peso and the subsequent financial crisis.
- The so-called “investor sentiment hypothesis” cannot plausibly explain these events unless one assumes investors became very optimistic about emerging markets stocks, and especially Mexican stocks, immediately following the devaluation—an explanation the authors judge unlikely given the facts surrounding the devaluation.
- A more sensible explanation proposed is investor loss-aversion: investors in these closed-end funds avoid realizing paper losses on their fund shares, which acts to slow or put a drag on downward movements in closed-end fund prices.
Evidence and analysis
- Empirical observation: large premia emerged in closed-end country funds focused on Mexico and other Latin American markets in the aftermath of the December 1994 peso devaluation.
- Comparative hypothesis assessment:
- Investor sentiment hypothesis: would require post-devaluation optimism concentrated among holders of closed-end country funds; authors find this inconsistent with the surrounding circumstances.
- Loss-aversion hypothesis: investor reluctance to realize losses provides a direct behavioral mechanism to explain sustained premia and attenuated price declines in closed-end fund shares.
Implications for understanding closed-end country fund pricing
- Behavioral preferences (loss-aversion) among fund investors can produce persistent deviations (premia/discounts) of closed-end fund prices from underlying net asset values, particularly in crisis episodes.
- Standard explanations relying on shifts in average sentiment may be insufficient to account for observed price dynamics in closed-end country funds following currency and financial crises.