Are IPO Investors Rational? Evidence from Closed-End Funds

Abstract

Why buy a closed-end fund at IPO, when it is likely to trade at a discount in a few months’ time? One theory suggests that buying a new fund is justified by an initial period of investment outperformance. A second theory is that new funds are launched to provide access to assets that are temporarily illiquid and to exploit the subsequent liquidity gain while a third theory asserts that buyers of new issues are not fully rational but are influenced by time-varying sentiment. This paper tests the three theories using data from UK-traded closed-end equity-fund IPOs over 1984 to 2006. The empirical results provide strong support for the influence of sentiment but provide little or no support for the two other theories.

Keywords: sentiment, closed-end funds, IPOs

JEL Classification: G23