Chapter 16: Measuring the Impact of Behavioral Traders in the Market for Closed-end Country Funds from 2002 to 2009
Hugh Kelley and Tom Evans
Hugh Kelley and Tom Evans A diverse body of empirical evidence demonstrates deviations of market prices from their fundamental values (see Froot and Thaler, 1990; Hirshleifer, 2001; Barberis and Thaler, 2003, and Pesendorfer, 2006 for introductions to, or surveys of, behavioral finance research and examples of the many field anomalies). Smith et al. (1988) is an early study that documents these bubbles in experimental markets. One anomaly that has received a substantial amount of attention but remains largely unexplained is the large and variable discount observed between closed-end country fund prices and their exchange-rate-adjusted net asset values (NAV); see Lee et al. (1991) and Kelley (2004). To account for this and other field anomalies, theorists have attempted to inject more reality into asset pricing models. One strain of the literature has attempted to model the institutional environment within which agents trade by including realistic features such as: market incompleteness, forms of market segmentation, unknown risk features, asymmetric private information, transaction costs and price stickiness, all of which produce some type of limits to arbitrage and therefore inefficient prices. Increased theoretical reality may also be beneficial for specifying the expectations formation traits of economic agents. Some of the earliest extensions to the rational expectations utility-maximizing agent included state-invariant features such as risk aversion and discounting of future utility. More recent theories postulate the presence of state-dependent irrational biases on the part of agents. See Basov (2005) for a comparative study of static versus dynamic/ state-dependent bounded rationality approaches. In these theories...
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