EXCESS VOLATILITY ANDCLOSED?END FUNDS

Abstract

This paper proposes that NAV signalling and heterogeneous beliefs are possible causes for excess volatility observed in closed-end funds. Specifically, when the underlying NAV signal is uncertain, learning among investors is inhibited and dispersion of beliefs persists despite repeat signalling. Volatility of closed-end fund shares is then amplified when investors attempt to relate individual estimates to observed equilibrium price. Using log variance ratio as a measure of excess volatility, the paper shows that better information signals reduce excess volatility observed in closed-end funds; and that measures of heterogeneous beliefs affect the magnitude of excess volatility. Lastly higher excess volatility is shown to be compensated with higher fund returns.