BUSN4100 Business Research Methods

BUSN4100 Research Methods Paper

METHODOLOGY

INTRODUCTION
Market efficiency requires market prices reflect all available information (Fama, 1970). The joint test problem exists where tests of market efficiency are ultimately a joint test of mispricing and a model of discount rates (Barberis & Thaler, 2003). Closed-end funds are investment vehicles with a fixed number of shares and a situation where the law of one price is applicable, removing the joint test problem. Evidence of market inefficiency has been documented given the reported closed-end fund discount, however most studies predominantly focus on the United States. The
closed-end fund discount has not been examined in the context of the Australian equity market. This deficit leads to the first research question To what extent do closed-end funds trade at a discount to net asset value in the Australian market?. Empirical evidence can be collected to determine the presence of the closed-end fund discount phenomena in the Australian market.
In the event that the closed-end fund discount is observable in the Australian market, this study seeks to explain its existence. This leads to the second research question What are the determinants of the closed-end fund discount?. The objective of this paper is to summaries the methodology proposed to address the research questions. Prior research is used to direct the research questions, quantitative design, data sample and sources, variables and regression data analyses. Finally, the chief limitations restricting the scope of the methodology and results of this study are recognized.

 

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BUSN4100 RESEARCH QUESTIONS AND HYPOTHESES
Before considering the determinants of the closed-end fund discount, the presence of the closed-end fund discount is examined in the Australian equity market. In order to examine the business research question To what extent do closed-end funds trade at a discount to net asset value in the Australian market? the following hypothesis has been developed.

H1: The price of closed-end funds trades at a discount to their net asset value per share in the Australian market.

There is substantial empirical evidence of the existence of the closed-end fund discount internationally. Previous studies have demonstrated the presence of this phenomena in markets including the US (Flynn, 2011) and UK (Gemmill & Thomas, 2002). The closed-end fund discount is observed by deviations between the market price and the net asset value of closed-end funds. Between 1965 and 1985, the value weighted average discount on a portfolio of major closed-end funds in the United States was 10.1% (Lee, Shleifer & Thaler, 1990). Hypothesis one examines the existence of the closed-end fund discount specifically in the Australian equity market. The following three hypotheses have been developed in order to address the second research question What are the determinants of the closed-end fund discount?. They are formed in accordance with three explanations of the closed-end fund discount commonly proposed by extant literature.

There is a significant association between investor sentiment and the closed-end fund discount.

The magnitude of the closed-end fund discount may be related to investor sentiment. The investor sentiment explanation posits that prices are a function of investor sentiment, not just fundamental business value. The changing sentiment of individual investors towards closed-end funds and other securities is able to explain fluctuations in closed end fund discounts (Lee, Shleifer & Thaler, 1991). Noise-traders make decisions based on an irrational and emotive basis. Noise-trader risk creates an unherdable fundamental risk (Lee, Shleifer & Thaler, 1990). Ceteris paribus, the greater the noise trader risk a fund has, the greater the average discount it trades at will be (Flynn, 2011).

H3: There is a significant association between transaction and holding costs and the closed-end fund discount. 

Transaction and holding costs are the costs incurred when investors correct a mispricing. Previous studies identify a relationship between transaction and holding costs and the closed-end fund discount (Barberis & Thaler, 2003; Pontiff, 1996). Market frictions reduce the ability of rational traders to profit from mispricing (Pontiff, 1996). Due to transaction and holding costs, mispricings do not necessarily represent attractive investment opportunities. Therefore, due to this limit to arbitrage, these mispricing can remain unchallenged (Barberis & Thaler, 2003). Cross-sectionally, transaction and holding costs are argued to explain about a quarter of all mispricing (Pontiff, 1996).

 

 

There is a significant association between liquidity benefits and agency costs and the closed-end fund discount.

Existing studies explain the closed-end fund discount as a trade-off between liquidity benefits and fees charged by the fund (Cherkes, Sagi & Stanton, 2008). Closed-end funds allow individual investors to invest in illiquid assets without requiring direct trading of the asset and having to realize illiquidity costs including transaction and holding costs that would otherwise be incurred (Cherkes, Sagi & Stanton, 2008). In the context of closed-end funds, agency costs primarily refer to fund manager fees. These costs are not incurred by the underlying portfolio of the closed-end fund. In circumstances where the costs of being invested in a closed-end fund exceed the liquidity benefits the fund provides, the fund will trade at a discount. 

BUSN4100 RESEARCH DESIGN

The research design addresses the two research questions in two corresponding stages. In both stages, conclusions are drawn from statistical evidence and logical reasoning. As a result, this study falls within the positivist paradigm. This study uses quantitative methods. The first stage tests for the existence of the closed-end fund discount in the Australian equity market. The second stage tests the association of the proposed determinants of the phenomena with the closed-end fund discount in Australia. In both stages, panel data observing the cross-section of funds across time will be analyzed. Hypothesis one will be tested using t-tests to demonstrate the average closed-end fund discount over the period is statistically different from zero and to observe variations in the magnitude of the discount across time. The main method for testing hypotheses two to four is multivariate regression analysis. Regression analysis identifies linear relationships between the closed-end fund discount and its proposed determinants (Bell & Bryman, 2015). The method for estimation will be Ordinary Least Squares (OLS). This research design is consistent with previous studies such as Pontiff (1996) and Gemmill & Thomas (2002). This regression analysis applies variables identified in previous research in order to identify statistical correlation between the proposed determinants and the closed-end fund discount. As a result, this analysis will examine the relationship between investor sentiment, transaction and holding costs and liquidity benefits and agency costs with the closed-end fund discount.

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