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This paper examines how investors assimilate information obtained from a set of German and U.S. macroeconomic news releases, and register their response on German closed-end fund net asset values (NAVs) and share prices. Specifically, three German Funds traded in the NYSE are chosen and their response to five common types of macroeconomic announcements is investigated. The results indicate that there are systematic differences in the way German and U.S. investors react to information about the two respective economies. We find some commonality in the response of NAV and share price to certain types of announcements, notably industrial production and PPI releases in Germany and the U.S., but a strong divergence is documented when examining other common news releases. The results lead us to believe that the time-varying behavior of fund discounts is most likely attributable to the divergent assessments held by German and U.S. investors, and are in turn, influenced by the security composition and objective of the fund itself.

One of the long-standing empirical anomalies in finance concerns the apparent divergence of closed-end fund share prices (SP) from their net asset values (NAV). This phenomenon has come to be known as, “the closed-end fund puzzle”. What makes this puzzle intriguing is that it appears to be a violation of one of the most intuitively appealing theories within finance and economics: i.e., the law of one price. While many hypotheses have been proffered to explain the closed-end fund puzzle (see literature review), one hypothesis that has attracted a good deal of attention is that the difference between the market price of a fund and its NAV is a reflection of the differences in sentiment, or expectations, between investors in the fund and investors in the underlying assets. Among closed-end funds, country closed-end funds (or, simply country funds) are particularly well suited to the study of such differential sentiment hypotheses. This is due to the fact that the investors in the underlying assets, and the investors in the funds, themselves, are readily identifiable. The differential sentiment hypothesis, as applied to country funds, posits that the investors in the fund's home-country determine the fund's NAV, while the investors in the country where the fund is traded determine the fund's price of the closed-end fund (see Bodurtha, Kim, & Lee, 1995; Hardouvelis, La Porta, & Wizman, 1994). How these two groups of investors react to new information, then, may be enlightening not only as a study of market integration and international information flows, but, may also be at the crux of understanding the closed-end fund puzzle itself. This, in brief, is the overarching objective of this study. This paper evaluates the impact of German and U.S. macroeconomic news (or surprises) on the SP and underlying NAV of three German country funds (the Germany Fund, the Emerging Germany Fund and the New Germany Fund) traded on the New York Stock Exchange (NYSE). Five common types of macroeconomic announcements are chosen—Industrial Production, the Producers Price Index (PPI), Retail Sales, the Trade Balance, and the Unemployment Rate for the period spanning April 1990–May 1999. Such an investigation is significant for at least three compelling reasons. First, the study highlights the magnitude and direction of information flows between two closely related securities and two closely related markets. At least nominally, the NAV and the SP of a country fund are simply two different price quotations of the same underlying asset; in this case, a portfolio of securities traded in the German stock market. Naturally, we may expect that information pertaining to both Germany and the U.S. should influence the value of assets in the German market. It is our hypothesis that there may be systematic differences in the way in which local (German) and foreign (U.S.) investors react to information about the two respective economies. Based on the empirical findings regarding other anomalies, such as the home-country bias, we may expect that, should these systematic differences exist, local investors may be more sensitive to information about the German economy while U.S. investors may be more sensitive to information about the U.S. economy, even when evaluating German investments. Further, our investigation of three separate German country funds, with contrasting investment objectives and asset composition, allows us to examine which portfolio of German securities is more responsive to macroeconomic news releases. Second, an examination of the interaction between the SP and NAV will help us understand the time-series behavior of the funds’ discounts or premiums surrounding the release of macroeconomic surprises. In this regard, some prior studies have suggested that the discounts of closed-end funds are mean-reverting. Gasbarro, Johnson, and Zumwalt (2003), who examine domestic bond and equity closed-end funds, attribute the mean reversion in discounts to changes in SP and NAVs. Their conclusion seems almost tautological. What is of additional importance here, and which is the focus of this study, is to examine the underlying reasons for the change in SP and NAV, and how they are incorporated in the fund discounts. This is crucially important if one wishes to develop an understanding of the time-varying nature of the discounts observed on closed-end funds. Moreover, studies on international capital market relationships overwhelmingly support the notion of asset price interdependency, especially when the markets examined include the U.S. and other developed economies. Therefore, under the rubric of market integration and informational efficiency, the temporal behavior of fund discounts should reflect the relative importance that local and foreign investors give to information emanating from the respective markets. Finally, our emphasis on a longer time period, our consideration of multiple country funds, and our introduction of the important dimension of news spillover across markets, enable us to extend the existing research on capital markets, and study the effect the news contained in economic announcements may have on the securities traded in these markets. The findings reported in the study indicate that the fund's NAV and SP respond differently to macroeconomic announcements depending on the country from which the announcement is released, and is partly contingent on the security composition of the fund itself. Specifically, U.S. macroeconomic announcements play a more prominent role in influencing the fund's SP as opposed to the NAV. On the other hand, the fund's NAV is more sensitive to news pertaining to the German economy. Among the announcements, surprises in industrial production and PPI from Germany and from the U.S. stand out. These two announcements have a significant impact, similar in magnitude, but opposite in direction, on both the fund's SP and NAV. Evidence that the share prices are influenced by U.S. macroeconomic announcements in a way in which the NAVs are not is consistent with previous research which has suggested that the discounts on country funds tend to be driven by the degree of information asymmetry (or divergent expectations) between local and foreign investors (see for example, Bodurtha et al., 1995; Frankel & Schmukler, 1996). Our results serve to provide new evidence on the time-varying behavior of fund premiums, and identify the unique role played by specific macroeconomic announcements in influencing this behavior. The remainder of the paper is organized as follows. Sections 2 and 3 review the literature and describe the data, respectively. Section 4 contains a discussion of the methodology and model specification, and Section 5 reports the findings of our study. Section 6 concludes the paper with some directions for future research.

This study examines how investors assimilate information obtained from a set of German and U.S. macroeconomic announcements, and how their responses are registered on German closed-end funds net asset values and share prices. Specifically, three German funds, traded on the NYSE, are chosen and their responses to five common types of announcements (Industrial Production, the Producers Price Index, Retail Sales, the Trade Balance, and the Unemployment Rate) are investigated. The study extends the current research on closed-end funds by providing important insights into the (a) magnitude and direction of information flows in affecting the movements of NAV and SP, and (b) temporal behavior of fund discounts in the presence of macroeconomic news releases emanating from Germany and the U.S. The study documents that there are systematic differences in the way the funds’ NAVs and SPs respond to German and U.S. macroeconomic information. First, with regards to causal influences between NAV and SP, pooled results indicate the presence of bidirectional causality between the two variables. However, a closer examination of the results from individual funds confirms the relative dominance of the NAV in influencing the information transmission process between the two markets. Second, announcements that convey a surprise improvement in Germany's economic condition or a surprise deterioration in the U.S. economy – as given by changes in industrial production and PPI – increases the fund's NAV and SP by about the same magnitude. Third, movements in the funds’ discounts reflect divergent assessments made by German and U.S. investors to the release of macroeconomic news. Specifically, the differential reaction on the part of U.S. investors relative to German investors to surprises in the announcement of German retail sales, German trade balances, and German unemployment numbers; coupled, with a lack of response on the part of German investors to similar U.S. macroeconomic surprises appears to be significant in driving the time-varying changes in the funds’ discounts. Fourth, the apparent divergence that is observed in the funds’ discounts is contingent on the composition and objective of the closed-end fund itself. In our study, we find the fund discounts of the Emerging Germany Fund, which has a significant exposure to eastern European markets, are most susceptible to the influences of divergent expectations. In comparison, the fund discounts of the Germany Fund, which is comprised heavily of large capitalization German firms, exhibits the strongest response to German announcement surprises, yet the Fund exhibits no reaction to surprises in U.S. economic news releases. Therefore, in terms of the differential investor sentiment hypothesis, we argue that the significant reaction of the fund's discount to macroeconomic announcements is indicative of a time-varying, information sensitive, relationship between the SP and NAV. If the closed-end country funds’ discounts were completely a result of mispricing, taxation, transactions costs, or other such phenomena, there would be little reason for it to react in this time-varying fashion to the release of economic information. It may be an interesting and worthwhile exercise to extend the current empirical framework to include other country funds. Should other country funds adjust to news releases in a similar manner, a theoretical model could then be developed to better explain changes in the foreign closed-end fund pricing relationships and the speed of adjustment to global economic events. These issues are left for future research.