Closed-end funds often trade at a discount to net asset value. Previous research suggests that the positive correlation in discounts is associated with investor sentiment that causes systematic mispricing by noise traders. We use a newly available sample of daily fund valuations to examine the relation between intraday trading activity and discount changes. Contrary to the assumption that retail investors are noise traders, we find no relation between discount changes and the order-flow imbalances of individual investors. Large daily discount changes are associated with institutional trading, and this may reflect the price inelasticity of closed-end fund shares. 2005 The Southern Finance Association and the Southwestern Finance Association.
Unlike closed‐end country funds that usually trade at large premiums to the values of their portfolios, exchange‐traded funds facilitate arbitrage to prevent their prices from deviating from their underlying values. However, such arbitrage can involve significant transaction costs, which have caused some to question the ability of this arbitrage to reduce premiums. This study examines the premiums on the iShares Malaysia Fund, which is the only exchange‐traded fund that has experienced an extended suspension of arbitrage. The results illustrate the importance of arbitrage in providing the full benefits of international diversification associated with exchange‐traded funds that invest in foreign securities.
Purpose
– In the increasingly globalized economy, foreign exchange fluctuations have multiple, conflicting effects on domestic stock prices. The purpose of this paper is to examine return data to determine the relation between the dollar’s value and stock prices as it relates to monetary policy.
Design/methodology/approach
– The authors examine US stock returns over a 40-year period, which is classified according to monetary policy and dollar trend. To better understand the impact of foreign exchange fluctuations, the authors estimate a model of stock returns using the three Fama-French factors and a momentum factor. Then the authors explore the underlying economic fundamentals that drive the sharp difference in annual returns between periods when the dollar is in an uptrend trend with loose monetary policy and periods when the dollar is in a downtrend with tight monetary policy.
Findings
– Over the last 40 years, US stock returns were 2.5 times higher when the dollar was trending up vs down. The factor model of returns shows that equity returns are positively associated with periods when the dollar appreciated. Returns were particularly high when the dollar was in an uptrend during accommodative monetary policy. During these periods, stocks in the consumer goods and services industries provided relatively high returns. This occurred with strong economic growth due to consumer spending. Stocks exhibited the lowest returns when the dollar was depreciating and the Federal Reserve was tightening.
Originality/value
– The key contribution of the research is that currency trends should be analyzed in the light of monetary policy. During periods of accommodative monetary policy and dollar appreciation, the US stock market provided average returns of 18.7 percent compared to −3.29 percent during a period of restrictive monetary policy and dollar depreciation. This result is driven by stronger economic growth, which is composed of consumer spending that more than offsets the dollar’s impact on net exports.
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