TIME-VARYING EXPECTED SMALL FIRM RETURNS AND CLOSED-END FUND DISCOUNTS

This article describes the relation between closed-end fund discounts and time-varying expected excess returns on small firms. The results i ndicate that closed-end fund discounts forecast future excess returns on small firms. The information in discounts is independent of that in other commonly used forecasting variables such as the dividend yield on the market, the default spread and the term spread, Furthermore, th e closed-end fund discount forecasts only the small firm factor return and is the only variable that forecasts the small firm factor return. Additional tests indicate that the information in discounts is relate d to expectations of future earnings growth and expectations of future inflation. These results Provide significant support for a rational e xplanation of the time-series relationship between discounts and expec ted returns on small firms.