Diversification in lottery-like features and portfolio pricing discount: Evidence from closed-end funds
2021
Abstract Why do portfolios often trade at discounts relative to the sum of their components? I provide a new explanation based on the diversification in lottery-like features. I argue that portfolios trade at discounts when their components exhibit a strong lottery-like feature but a low tendency of producing extreme payoffs together. This discount can be partially mitigated if lottery-like components tend to produce extreme payoffs at the same time. I use the closed-end fund setting to provide empirical supports for this explanation. My findings support prospect theory from an alternative perspective and provide a novel explanation for the closed-end fund puzzle.
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