This study examines the long-term link between fair valuation uncertainty and discounts/premia in closed-end funds. This study argues that, in exploring the close-end funds puzzle, prior research generally omits to consider the uncertainty surrounding the measurement of funds' financial disclosure, as reflected in the fair value hierarchy, when investment specialty differs across funds.
Regressions were employed to explore how the fair value hierarchy affects closed-end funds' discounts/premia when investment specialty differs. The authors also examine the effects pre- and post-2012 to explore if that relationship changes due to the additional disclosure requirements enacted at the end of 2011.
The authors find that the three levels of the fair value hierarchy have effects that vary according to a fund's specialty. For equity specialized funds, Level 3 significantly increases discounts and decreases premia, suggesting the impact of valuation uncertainty that underlies Level 3 estimates; this relationship disappears (decreases in severity) for premia (discount) experiencing funds post-2012. In contrast, Level 1 and Level 2 do not have any significant effect on discounts or premia except that post-2012, Level 2 begins to display discount decreasing effects. For bond specialized funds, no significant association was noted between premia and any of the fair value levels except that post-2012, Level 3 begins to display premium increasing effects. However, results are different for discounts. The authors note that Level 1 valuations significantly increase discounts, but only post-2012; Level 2 valuations significantly decrease discounts (pre- and post-2012), consistent with such estimates incorporating unique and relevant information; and Level 3 valuations do not have a significant effect on discounts.
The results of this study revisit prior evidence and indicate that results about the effects of fair value measurement and the closed-end funds' puzzle are sensitive to the period length being considered and the investment specialty of the fund. The authors also note that additional disclosure regarding Level 3 valuation inputs decreases market concern for valuation uncertainty and increases the liquidity benefits of investing in Level 3 carrying funds.
This paper is based on Ahmad Hammami’s Ph.D. thesis at McGill University. Ahmad Hammami acknowledges funding from McGill University, The National Bank Financial Group and from Social Science and Humanities Research Council - SSHRC - Insight Development Grant-IDG. Michel Magnan acknowledges funding from the Stephen A. Jarislowsky Chair in Corporate Governance (Concordia), the Institute for Governance of Private and Public Organizations and the Desjardins Centre for Business Finance Innovation (Concordia).
Fortin, S., Hammami, A. and Magnan, M. (2020), "Fair value's effects on closed-end funds' discounts and premia: is level 3 the sole perpetrator?", Managerial Finance, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/MF-04-2018-0163Download as .RIS
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