We investigate how redemption risk affects incentives to trade against mispricing. To this end, we compare the trading of closed-end funds, which are not subject to redemption risk, with that of open-end funds in stocks that are mispriced because of fire sales and purchases. We find that closed-end funds purchase (sell) fire sale (purchase) stocks to a larger extent than open-end funds. Moreover, closed-end funds’ portfolios are more exposed to stocks that are likely to be undervalued because of sentiment shocks. The differences in behavior are more pronounced for stocks that are difficult to arbitrage and the trading of open-end funds that are at high risk of experiencing redemptions is most different from the trading of closed-end funds. Finally, we extend the analysis to hedge funds with and without share restrictions and find that only hedge funds with share restrictions are likely to purchase fire sale stocks.

Keywords: Close-end funds, Open-end Funds, Fire Sales