Closed-end funds and sentiment risk |
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| Authors: | Alan K Severn |
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| Institution: | 1. Department of Obstetrics and Gynecology, Radboud university medical center, PO Box 9101, 6500HB Nijmegen, the Netherlands;2. Department of Obstetrics and Gynecology, Catharina Hospital Eindhoven, PO Box 1350, 5602ZA, the Netherlands;3. Department of Medical Microbiology, Radboud University Medical Center, PO Box 9101, 6500HB Nijmegen, the Netherlands;4. Department of Pathology, Radboud University Medical Center, PO Box 9101, 6500HB Nijmegen, the Netherlands;5. Division of Gynecologic Oncology, Queen Elizabeth II Health Sciences Centre, 5820 University Avenue, Halifax, NS B3H 1Y9, Canada |
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| Abstract: | Irradional noise traders earn high returns for bearing risk that they themselves create. Diversifying across closed-end funds does little to reduce this risk, because discounts are correlated across funds. But diversification between closed-end funds and large-cap stocks does reduce this risk, especially when markets are not subject to major shocks: a combination of closed-end funds and large-cap stocks has lower risk than either one alone. To the extent that fund shares and large-cap stocks are partially segmented markets, large-cap stocks thus provide some protection against the sentiment risk created by noise traders. This paper estimates the amount of large-cap stocks needed in tax-deferred portfolios, under various amounts of market-wide risk, and ways of measuring it. |
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