Why is a portfolio sometimes valued less than the sum of its underlying components? In this paper, I provide a novel explanation for the question by utilizing mergers and acquisitions, closed-end funds and conglomerates, where the value of the aggregate portfolio and the values of the underlying components can be separately evaluated. I extend the model of Barberis and Huang (2008) and show that, a portfolio is traded at a discount when its underlying assets exhibit strong lottery-like features but a low tendency to produce extreme payoffs at the same time. I present evidence supporting this model implication and provide a novel and unifying explanation for the announcement-day returns of mergers and acquisitions, the closed-end fund discount puzzle, and the conglomerate discount.
|In preparation - 2018