http://hdl.handle.net/1903/2240 Wed, 22 May 2013 23:58:56 GMT 2013-05-22T23:58:56Z http://drum.lib.umd.edu:80/retrieve/3233/rhslogo3.GIF http://hdl.handle.net/1903/2240 http://hdl.handle.net/1903/13096 Title: Essays on Asset Pricing Authors: Li, Su Abstract: This dissertation consists of three essays. The first essay is titled "Speculative Dynamics I: Imperfect Competition and the Implications for High Frequency Trading". In this essay, I analyze the nature of imperfect competition among informed traders who continuously generate and exploit private information about a risky asset's liquidation value which follows either a mean reverting process or random walk. I find the following results: (i) The combined trading of multiple informed traders is much more aggressive than the monopolistic trader in Chau and Vayanos (2008). (ii) The equilibrium price is even more revealing of the informed trader's private information. (iii) Market depth improves as the number of informed traders increases. (iv) In the limit of continuous trading, market is strong form efficient while aggregate profits of the informed traders remain bounded away from zero, in sharp contrast to the corresponding results in Holden and Subrahmanyam (1992), and Foster and Viswanathan (1993). (vi) Informed traders' inventories follows a Brownian motion, therefore enabling them to contribute significantly to total trading volume and price variance. These results shed light on empirical findings regarding high frequency traders by helping explain why they remain protable despite aggressive competition with each other, why their trading volume is very high, to what extent they improve efficiency, and through what mechanism they improve liquidity. The second essay is titled "Speculative Dynamics II: Asymmetric Informed Traders". In this essay, I study the strategic interaction between hierarchical duopolistic informed traders who continuously generate and exploit private information about a risky asset's liquidation value, which follows either a mean reverting process or random walk. I find the following results: (i) Both traders duopolize the private information they both observe and the more informed trader monopolizes the additional exclusive private information. (ii) The common private information is incorporated into prices more efficiently than the monopolistic private information. (iii) In the limit of continuous trading, both traders' inventories based on their shared information follow Brownian motions. (iv) The trader with less superior information has more contribution to the trading volume and price volatility when the frequency of trading is sufficiently high. (v) As trading becomes more frequent, the less informed trader's expected profits may fall but converges to a strictly positive constant in the limit. The third essay is titled "Real Options and Product Differentiation". In this essay, I develop a continuous time real investment model in an oligopoly industry where the products are heterogeneous. Although the heterogeneous products assumption can lower each firm's incentive to exercise the growth options prematurely, the preemption strategy is still profitable. Sun, 01 Jan 2012 00:00:00 GMT http://hdl.handle.net/1903/13096 2012-01-01T00:00:00Z http://hdl.handle.net/1903/13067 Title: ESSAYS ON CORPORATE INVESTMENT Authors: Moon, Seoyeon Katie Abstract: This dissertation is comprised of three essays on corporate investment. The first essay, titled "What If the Firm Does Not Diversify? A Self-Selection Free Bayesian Approach", takes a comprehensive look at the diversification discount. By employing a switching regression model with the Bayesian data augmentation methodology, I compare the actual post-acquisition firm value of diversifying acquirers to the counter-factual alternative which is a non-diversifying acquisition. I find that there is a considerable amount of acquirers that could improve their value by diversifying acquisitions more than what they would improve by non-diversifying acquisitions. When there are negative shocks to the acquirers' primary industries, when these industries are concentrated and the firms are not dominant players in the industries, diversifying acquisitions add values to the firms. The firm-by-firm analysis shows that on average, no diversification discount exists. The next two essays study U.S. manufacturing firms' outsourcing activity, using a unique dataset of purchase obligations from firm 10-Ks. The second essay is titled "Outsourcing and Firm Financial Structure", and the third essay is titled "Firm Risk Taking versus CEO Diversification: Evidence from Outsourcing Firms". In the second essay, I explore the outsourcing decision and its implications on firm investment and capital structure. I first examine what kinds of firms use external contracts to provide a product or service as a major input to their production. I find that relatively young or large firms with a large number of patents are more likely to use external purchase contracts. Within high-technology industries, firms with purchase contracts tend to have higher R&D investment, while in low- technology industries, firms with purchase contracts are more likely to enter new markets. Outsourcing activity has important risk and capital structure implications, as firms that outsource have significantly less leverage. These results are consistent with outsourcing being used by firms to improve their flexibility. Faced with this increased firm flexibility and fewer fixed assets to pledge as collateral, outsourcing firms finance their operations proportionally more with equity. In the third essay, I examine CEO compensation in outsourcing firms. I find that the intensity of outsourcing can significantly explain the variations in CEO compensation; the more the firms do outsourcing, the more they pay to their CEOs. Outsourcing firms promote managerial risk-taking by using proportionally more equity-based compensation. However, they also need to compensate additionally their CEOs for the higher risk exposure to the firms' increased total risks. I show that outsourcing firms determine their compensation level and structure based on this optimal trade-off. Sun, 01 Jan 2012 00:00:00 GMT http://hdl.handle.net/1903/13067 2012-01-01T00:00:00Z http://hdl.handle.net/1903/12098 Title: Essays on Empirical Market Microstructure Authors: Tuzun, Tugkan Abstract: The first essay examines the events of May 6, 2010: the ``Flash Crash". The Flash Crash, a brief period of extreme market volatility on May 6, 2010 raised questions about the current structure of the U.S. financial markets. Audit-trail data from U.S. Commodity Futures Trading Commission (CFTC) is used to describe the structure of the E-mini S\&P 500 stock index futures market on May 6. In this study, three questions are asked. How did High Frequency Traders (HFTs) trade on May 6? What may have triggered the Flash Crash? What role did HFTs play in the Flash Crash? There is evidence which supports that HFTs did not trigger the Flash Crash, but their responses to the unusually large selling pressure on that day exacerbated market volatility. The second essay examines the relationship between mutual fund trading and liquidity consumption in financial markets. Using Thompson Mutual Funds holdings data and the Trade and Quotes (TAQ) data, we relate the mutual fund trading to liquidity consumption. Mutual fund trading is positively correlated with liquidity consumption. Mutual fund sensitivity to liquidity consumption differs based on mutual fund investment style. Large trades reveal the trading activity of actively managed mutual funds whereas the trading activity of index funds can be explained by small trades. This is consistent with a plausible explanation that index funds need to use small trades to rebalance their portfolios and information motivates the large trades of active mutual funds. The third essay tests the predictions of trading game invariance using the sample of trades from TAQ dataset from 1993 to 2008. The theory of trading game invariance predicts that the distribution of trade sizes as a fraction of trading volume should vary across stocks proportionally to their trading activity in -2/3 power and that the number of trades should vary across stocks proportionally to their trading activity in 2/3 power. The data supports predictions of the invariance theory. For the number of trades, the estimated power coefficient of 0.69 (with standard errors of 0.001) is especially close to the predicted one of 2/3 on the subsample before 2001. These estimates increases to 0.79 (with standard errors of 0.004) after 2001 following a structural break related to a reduction in tick size and a consequent spread of algorithmic trading. Furthermore, the entire distribution of trade size shifts with the trading activity in a manner predicted by invariance theory. When trade sizes are adjusted for differences in trading activity, then their distribution is stable across stocks and similar to the distribution of a log-normal variable, truncated at the 100-share threshold. Sat, 01 Jan 2011 00:00:00 GMT http://hdl.handle.net/1903/12098 2011-01-01T00:00:00Z http://hdl.handle.net/1903/11512 Title: Three chapters on hedge fund reserve capital and systemic risk Authors: Xiao, Yue Abstract: Hedge fund industry has grown to be a key player in the financial markets. Just as large investment banks, the failure of this industry will greatly destroy the liquidity and stability of the whole system. However, contrast to regulated mutual funds, hedge funds are private and lightly regulated entities who are not obliged to disclose their activities to the general public. Hedge funds risk taking activity using ways such as short selling and excessive leverage and their increasingly correlated strategies pose substantial threats to the financial stability of the great economy. In the First Chapter, we propose a simple framework which adopts the theory of acceptable risks and calculate capital requirements using the limited available data on hedge funds. We model the risky cash flow asset less liability (or Net Asset Value) directly using either a Gaussian process or a Variance Gamma process and apply the method to demeaned NAV data on $3622$ hedge funds from January 2005 to April 2009. Funds are analyzed for their required capital and the value of the option to put losses back to the taxpayers. The previous study has considered funds individually with no correlation between them. Focusing only on individual funds ignores the critical interactions between them and can cause the regulators to overlook important changes in the overall system. Because many hedge funds employ similar investment strategies they produce correlated returns. The failure of these correlated large funds will greatly affect the markets systematically either in a direct or an indirect way. In the Second Chapter, we propose a systemic approach with correlated largest market participants and we study the $30$ largest funds as of April 2009 with total Asset Under Management over $\$620$ Bn. We demonstrate the systemic capital charges to be held by the broad economy, as well as the capital charges at the fund level accounting for the residual idiosyncratic risk component. Hedge fund investment strategies often include the use of leverage in order for them to build up large positions. Extensive use of leverage has increased funds liabilities especially during market downturns and has posted a great systemic risk to the economy in large. In the Third Chapter, we recognize that with limited and incomplete information on hedge funds balance sheet positions, the public usually does not know how much leverage there is in a particular fund or how to distinguish its assets and liabilities from the observed returns. We estimate hedge fund leverage using a regression-based exercise on the individual fund level. The estimated leverage information is then combined with publicly known return and other fund information to separate from fund cash flows its asset side and liability side. The two sides of the cash flows are then modeled as exponentials of two correlated L\'evy processes following \cite{EberleinMadan:2010}. Capital implications are then derived from the above setup. Sat, 01 Jan 2011 00:00:00 GMT http://hdl.handle.net/1903/11512 2011-01-01T00:00:00Z