Organizational form and liquidity management: Evidence from open- vs. closed-end municipal bond funds

This paper studies how the organizational forms of open- and closed-end funds affect their ability to manage illiquid assets. We use a sample of municipal bond funds from 2002 to 2015 to compare the portfolio liquidity and performance of open- and closed-end funds. We find that immunity to redemption risk allows closed-end funds to hold more illiquid municipal bonds than open-end funds, and they charge higher management fees for such liquidity provision. Closed- end funds earn liquidity premiums from their illiquid holdings. They significantly underperform peer open-end funds after controlling for their exposure to liquidity risk. Highly leveraged closed-end funds are subject to systematic liquidity risk. We find that closed-end funds with higher leverage hold more liquid municipal bonds. They trade more liquid municipal bonds to reduce the potential costs at forced deleverage.