Chaos, Noise Traders and Smart Money. Evidence Form the us Closed-End Funds Industry

Investment trusts or closed-end funds are known for the discount problem that arises within a few months. Specifically, According to Weiss (1989), shares in US funds are issued at a premium to net asset value, NAV, of up to 10 per cent. This premium represents the underwriting fees and start-up costs. Within a matter of months, the shares normally trade at a discount, which persists and fluctuates. Upon termination of the fund, the share price rises and the discount disappears. Weiss (1989) found that within 24 weeks of trading, equity funds in the US trade at a significant average discount of 10 per cent. Upon termination of the fund, share prices rise and discounts disappear (Brauer, 1984, and Brickley and Schallheim, 1985). This phenomenon seems to contradict the well-known Efficient Market Hypothesis in terms of semi-strong and strong efficiency as the persistence of the discount implies that publicly available information is not incorporated into the price of shares. Closed-end funds provide apparent evidence of market inefficiency and violations of standard asset pricing models. Chaos theory, noise traders and smart money was an attempt to explain the discount fluctuations and persistence. The discount on closed-end funds cannot be explained solely by the beta, or tendency to move with the market as a whole. Our sample of funds avoids survivorship bias for the US market as it contains defunct and surviving funds. Survivorship may be expected to bias the discount and performance measures upwards especially when we get averages for the whole sector or for industries within specific sectors