Finance Theses and Dissertations

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ESSAYS IN INNOVATION AND ENTREPRENEURSHIP
(2024) Ye, Zhen; Tate, Geoffrey A.; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
My dissertation focuses on the topics of innovation and entrepreneurship. In Chapter 1, I study how banks affect their borrowing firms’ green innovation when they reduce credit to firms with high carbon emissions. Using banks’ commitments to carbon neutrality as credit shocks to the borrowing firms, I first show that high-emission firms file fewer green patents following their relationship banks’ commitments to carbon neutrality. At the same time, other borrowing firms that receive increased lending from these committed banks see an increase in green patent filings. Second, I present evidence suggesting that financial constraints and inventor mobility are important mechanisms driving these effects. Third, I find that the value of newly filed green patents by firms in high-emission industries declines post-commitment, whereas there appears to be no discernible impact on the value of green patents filed by other firms. Finally, I develop a novel measure that gauges a patent’s relevance to mitigating climate change impact using text algorithms and show that banks’ commitments lead to lower relevance of green patents filed by high-emission firms. Altogether, the paper highlights an unintended consequence of bank divestment: a decrease in the production of high-quality green patents.Chapter 2 is joint work with Sven Oskarsson and Rafael Ahlskog. This chapter investigates the effects of parental income volatility on individuals’ entrepreneurial decisions in Sweden. Our results indicate that individuals who experience higher uninsurable parental income volatility during adolescence are more likely to become entrepreneurs. Specifically, a one-standard-deviation increase in parental income volatility is associated with an increase in the probability of becoming an entrepreneur by around 45% relative to the mean. Second, we find that firms started by individuals with higher parental income instability have a lower survival rate. Finally, we present evidence in line with higher risk tolerance being an important mechanism driving our findings. We do not find support for alternative mechanisms, including human capital accumulation and financial resources.
Essays in Corporate Finance
(2024) Wu, Chengjun; Maksimovic, Vojislav; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains three essays that explore topics in corporate finance and banking. Chapter 1 studies the role of board's political connections in corporate misconduct. Leveraging a policy shock in China that mandated politically connected directors to resign from corporate boards, I find that following the disruption in political connections, firms become less prone to commit misconduct while their misconduct is more likely to be detected. The elimination of political connections on board is particularly effective in deterring and detecting high-level offenses. The effects of the policy are also more pronounced for non-state-owned enterprise and firms in regions with lower level of corruption. I also find that firms affected by the shock are more inclined to initiate Directors and Officers insurance coverage and executives from such firms exhibit more negative sentiments in communications. Overall, the results suggest that political connections may shape firm compliance and facilitate a more lenient regulatory environment for the firm, thereby posing significant challenges to effective regulatory oversight. In Chapter 2, we argue that bank holding companies (BHCs) extend shadow insurance to the prime institutional money market funds (PI-MMFs) they sponsor and that PI-MMFs price this shadow insurance by charging investors significantly higher expense ratios and paying lower net yields. We provide evidence that after September 2008, expense ratios at BHC-sponsored PI-MMFs increased more than at non-BHC-sponsored PI-MMFs. Despite higher expense ratios, BHC-sponsored PI-MMFs did not experience larger redemptions than non-BHC-sponsored PI-MMFs. In addition, we show that expense ratios increased with BHCs' financial strength and the likelihood of their support; however, this expense ratio differential disappeared after the 2016 MMF reform. Chapter 3 studies how the revelation of financial misconduct affects the peer firms of the accused firm. I find that such spillover effect exists in both equity and debt markets using event study approach and staggered difference-in-differences design. In the equity market, the peer firms of the accused firm suffer significant negative cumulative abnormal returns. In the debt markets, both loans and bonds of the peer firms exhibit significantly higher spread over the benchmark risk-free rate following the misconduct revelation. Peer firms that employ the same auditor as the accused firm are more adversely affected. These peer firms not only experience even lower cumulative abnormal returns but also face tighter terms from creditors including collateral requirements and more restrictive covenants. They are also more likely to replace their auditors to distance themselves from the accused firm. The findings are consistent with the notion that financial misconduct erodes the trust in capital markets, prompting market participants to reassess the credibility of the non-accused peer firms.
ESSAYS ON INNOVATION, HUMAN CAPITAL, AND SMALL BUSINESSES
(2023) Xue, Jing; Maksimovic, Vojislav; Yang, Liu; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation comprises three essays that explore how human and social capital influence innovation and promote firm dynamism, particularly for small businesses. It studies how firms' uptake of projects is shaped by the local environments, such as superstar firms, talent clusters, and local social capital. In the first essay, I study the labor channel underlying the agglomeration of innovation activity. It identifies the reallocation of human capital as a key channel of agglomeration spillovers for innovative firms. To measure agglomeration spillovers, I study how R&D labs in different local labor markets respond differently to scientific breakthroughs, which create large and unexpected shocks to innovation productivity in certain technology categories. I document four main findings. i), following scientific breakthroughs, affected labs in thicker local labor markets (i.e., commuting zones with more inventors innovating in a certain field) produce more patents and higher-quality patents, consistent with positive agglomeration spillovers. ii), the increase in patenting is mostly attributed to new hires rather than incumbent inventors. iii), the thick labor market effect is concentrated in states and industries where there is lower enforceability of non-compete agreements and labor is more mobile. iv), using textual analysis to identify lab-level exposure to scientific breakthroughs, I find that inventors are reallocated to labs that are more favorably affected by shocks, which helps labs in thicker labor markets to more easily bring in inventors working in the same niche fields and having a diverse knowledge base. Taken together, these results point to labor mobility as a key force in explaining why innovative firms cluster and suggest that the clustering of firms in thick labor markets can foster corporate innovation by facilitating the productivity-enhancing reallocation of human capital following scientific breakthroughs. In the second essay, I identify the entry effects of top innovative firms on incumbent innovation. I exploit the inter-temporal variation in patenting activities of local inventors in chosen commuting zones that attracted the firm headquarters and in runner-up commuting zones that were finalists of location choice. Treated and control groups have similar trends prior to the entry, while the local inventors in the chosen zones apply 6.7% more patents, gain 16.8% more top patents, and receive 11.6% more citations. Entry effects are stronger among local inventors who are technologically or socially closer to the entering firm, after controlling for innovation incentives and labor mobility. Social closeness, isolated from technological proximity, consistently explains the innovation gains, which suggests knowledge diffusion is the important channel for local innovation productivity spillovers. In the third essay, we investigate why small businesses exploit business opportunities better in some areas than others. In a sample of 1.2 million consumer-facing establishments, social capital predicts the uptake of risk-free loans controlling for close-by bank branches, income, and education. One standard deviation increase in the social capital metric accounts for 20 percent of the variation in uptake across zip codes, surpassing the impact of a bank branch within 1000 yards. Strong social capital benefits large, low-growth stores in less-dynamic areas, whereas bank branches benefit small, high-growth stores in more-dynamic areas. Virtual connections have the greatest effect on uptake in already advantaged locations.
Essays in Financial Economics
(2022) Zhou, Wei; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains two essays in market microstructure and institutional asset management. The first essay studies a dynamic model of strategic trading where the parameters of temporary price impact (how price depends on a trader's current rate of trading) and permanent price impact (how price depends on the cumulative quantity traded over time) are endogenous and time-varying. A monopolistic informed speculator trades with oligopolistic uninformed speculators. They agree to disagree about the precision of the informed speculator's private Gaussian information flow. In the interval-trading Nash equilibrium with linear Markov strategies, trade starts if the disagreement is high enough and stops when the decaying alpha becomes insufficient to generate further trading benefits. Equilibrium permanent price impact parameters encapsulate the counteracting effects of descending residual uncertainty and diminishing trading opportunities. Equilibrium temporary price impact parameters capture traders' inter-temporal trade-offs between the benefits of learning and trading. The second essay was motivated by the observation that active institutional investors anticipate potential unwinding costs when accumulating positions. In this essay, I develop a dynamic model to study how strategic traders' accumulation and unwinding motives interact and evolve when facing a decaying profit opportunity. The unwinding pressures come from quadratic (regulatory) holding costs and price impacts of competitors' trades. The model shows that (i) with unwinding pressures, traders are reluctant to exploit persistent opportunities and profit most from those with an intermediate decaying rate; (ii) competition alleviates the unwinding pressure from holding costs but strengthens that from competitors' price impacts; and (iii) with increased regulatory costs, traders' most profitable opportunities shift to more transient ones.
Essays on Mutual Fund Performance Evaluation and Investors' Capital Allocations
(2022) Cao, Bingkuan; Wermers, Russ; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The dissertation contains two chapters that studies the performance of mutual funds and investors' capital allocations. In the first chapter, I study mutual funds' portfolio management and investors' capital allocations in a unified framework under mandatory portfolio disclosure. By modeling fund managers and investors simultaneously, I show that more skill managers produce better performance by trading more actively, which causes investors to care about both fund performance and activeness when evaluating fund managers. This investor's behavior explains the convex flow-performance relation observed in the market. In addition, my model demonstrates that portfolio holdings information is more useful to investors than fund returns because portfolio holdings reveal manager activeness that is not fully captured by fund returns. My model offers three novel empirical predictions for which I find consistent evidence in the data. First, investor flows respond to both fund performance and activeness. Second, investor flows are more sensitive to the performance of illiquid holdings in the portfolio. Finally, in a diff-in-diff analysis, I show that investor flows become more sensitive to fund activeness when portfolios are disclosed more frequently. In the second chapter, I study the performance attribution of bond mutual funds. I build a comprehensive sample of U.S. actively managed bond mutual funds with a large cross section and long time series, and examine the characteristics of funds that are most associated with superior active bond fund performance. I construct several sets of covariates to measure different aspects of managerial ability, including risk management, credit analysis, activeness, beta timing, liquidity provision, and family synergy. Given the large set of covariates, I employ machine learning methods such as Boosted Regression Trees to select the best predictors of bond fund performance. Unlike equity funds, I find that risk management plays an important role in generating superior performance. In addition, funds that are better at credit analysis and charge lower fees outperform their peers.
Triptych in Empirical Finance
(2022) Delalay, Sylvain; Maksimovic, Vojislav; Santosh, Shrihari; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains three chapters that explore topics in empirical finance and political economy. In Chapter 1, I study how the fundraising revenues of political campaigns affect the outcome of U.S. elections. First, I assemble a novel and granular dataset that provides a comprehensive picture of cash flows and voting intentions during U.S. congressional races. Then, I extract weekly shocks to the fundraising revenues of campaigns by using machine learning on the dataset. I find that the effect of revenues on the vote share decreases over the course of general elections. In races involving an incumbent, an additional $100,000 in challenger revenues increases her vote share by 1.48pp in the first half of the general election, but has no effect in the second half. Early cash infusions are more valuable than late cash infusions because they provide flexibility to respond to the opponent’s actions and mitigate current and future financing constraints. In Chapter 2, I examine how strategic and financial considerations shape the spending behavior of political campaign committees. To discipline the empirical analysis, I derive a dynamic model of strategic investment under financing constraints. I test the predictions of the model using the revenue shocks constructed in Chapter 1. I find that a committee’s elasticity of advertising expenditures to the revenue shocks of its opponent is 8%, which is a third of a committee’s elasticity to its own shocks. Moreover, a committee that is relatively richer than its opponent reacts more aggressively to its opponent’s shocks, both in levels and as a fraction of cash reserves. This result suggests that the availability of internal financing can amplify the competitive aspect of political spending in electoral races. In Chapter 3, I identify investor overreaction in a setting where information flows are not observable and learning pertains to multiple dimensions of an asset. Specifically, I measure how investors react to the information released during merger attempts and whether they form rational beliefs about the probability of deal completion. Using a model of distorted learning that generates testable implications, I find evidence of relative mispricing in the cross-section of merger targets. Empirically, a low price-implied probability of success underestimates the actual probability of success, and vice versa, suggesting that investors overreact to deal-specific information. The overreaction is unrelated to the unconditional merger premium and not driven by exposure to traditional risk factors.
Essays on Financial Markets
(2022) Peppe, Matthew David; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains three essays on financial markets concerning the relationship between short interest and returns in over-the-counter (OTC) equities, the effect of obtaining a rating on municipal bond offering yields, and the use of alternative trading systems (ATS) in the corporate bond market.Chapter 1 studies short positions among over-the-counter domestic common stocks. Short selling plays an important role in maintaining price efficiency, but short-selling in over-the-counter equities is often perceived as extremely rare. Short selling constraints are indeed high in this market, with the median fee to borrow a security being 2% for stocks with no short interest and 10% for stocks with short interest exceeding 1% of shares outstanding. Despite these constraints, 27% of domestic OTC equities have outstanding short interest positions on a given reporting date. Consistent with theories of short selling constraints such as Miller (1977), these high short selling constraints imply a substantial negative relationship between short interest and future returns. A portfolio of securities with short interest exceeding 1% of shares underperforms a portfolio of securities with no short interest by 31% annually and panel regressions show the relationship is robust to accounting for other security characteristics. The negative relationship between short interest and future returns suggests short sellers are trading in the direction of correcting mispricing in the OTC market, but the large magnitude and long time horizon over which short positions outperform suggests that there are large potential price efficiency gains from reducing constraints on short selling. Chapter 2, joint work with Haluk Unal, studies how whether a municipal bond is rated affects its offering yield. Approximately 34% of local municipal bond issues were issued without ratings during 1998 to 2017. We study the circumstances that affect the decision to obtain a rating and whether unrated bonds, controlling for observable risk factors, are more expensive to issue than rated bonds. Results show that issuers are less likely to obtain ratings for smaller issues, negotiated offerings, and bonds with high proxies for risk such as coming from areas with low personal income. We estimate the effect of forgoing a rating on offering yields using a doubly-robust Inverse Probability Weighted Regression Adjustment that controls for confounding that arises from risk and other characteristics affecting both the choice to obtain a rating and the yield. We separately analyze revenue bonds, general obligation bonds, bank qualified, and non-bank qualified bonds and find ratings decrease offering yields by 47, 49, 60, and 42 basis points respectively. The higher offering yields cost municipalities $22.5B in higher interest expense during our sample period. We find the choice of issuers to forgo ratings despite the substantial potential savings appears to be influenced by the underwriters they work with. Underwriters may face a conflict of interest where not obtaining a rating lowers the price investors are willing to pay from the bond, but also lowers the price the underwriter must pay the issuer and thus increases the underwriter’s profit. Chapter 3 is joint work with Matthew Kozora, Bruce Mizrach, Or Shachar, and Jonathan Sokobin. This chapter studies the circumstances when corporate bonds trade via an electronic ATS rather than in the traditional phone market and the relationship between venue choice and transaction costs. Trades on ATS platforms are smaller and more likely to involve investment-grade bonds, suggesting market participants trade via ATS when concerns about information leakage and adverse selection are lower. Trades on ATS platforms are more probable for older, less actively traded bonds from smaller issues, indicating participants are more likely to trade via ATS when search costs are high. Moreover, dealer participation on ATS platforms is associated with lower customer transaction costs of between 24 and 32 basis points.
ESSAYS ON EMPIRICAL ASSET PRICING
(2021) Li, Shuaiqi; Heston, Steven; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains two essays empirically exploring the equity option markets. Chapter 1 studies the role played by institutional investors in determining equity option returns. In this chapter, I study whether institutional stock holdings predict equity option returns. I find that institutional concentration in the underlying stock negatively predicts the cross-section of corresponding option returns. Evidence is consistent with a hedging and demand pressure channel: For stocks with more concentrated ownership, some institutional holders are more likely to overweight them and demand more of their options to hedge. To absorb the order imbalances, dealers sell options and charge higher prices, leading to lower option returns. Using option holdings of U.S. equity mutual funds, I document a positive correlation between funds' stock concentration and their option share in the same firms. In Chapter 2 (joint with Steven Heston), we improve continuous-time variance swap approximation formulas to derive exact returns on benchmark VIX option portfolios. The new methodology preserves the variance swap interpretation that decomposes returns into realized variance and option implied-variance. We apply this new methodology to explore return momentum on option portfolios across different S&P 500 stocks. We find that stock options with high historical returns continue to outperform options with low returns. This predictability has a quarterly pattern, resembling the pattern of stock momentum found by Heston and Sadka (2008). In contrast to stock momentum, option momentum lasts for up to five years, and does not reverse.
ESSAYS ON EMPIRICAL ASSET PRICING
(2020) xue, jinming; Wermers, Russ; Kyle, Albert; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
In essay 1: This paper measures the time-varying provision of liquidity by buy-side customers (e.g., mutual funds and pension funds), relative to bond dealers, in corporate bond markets using a structural vector autoregression (SVAR) model. As indicated by my simple theory model, shocks to the relative willingness of customers and bond dealers to provide liquidity affect, in opposite directions, the choice of bond dealers between market-making (principal) and matchmaking (riskless principal) transactions. Motivated by this model, my SVAR empirically disentangles these shocks to customers versus bond dealers. My SVAR-derived patterns of these structural shocks provide fundamental insights into the mechanics in corporate bond markets following recent events, such as exposing the increased role of buy-side customers for liquidity provision after the many regulatory changes following the 2008 financial crisis. Furthermore, my empirical approach generates “factors” that provide an improved time-series asset-pricing model for yield spreads of corporate bonds of different credit ratings. In essay 2: We consider an approach to derive the conditional expectation of return quantities under the real-world probability measure, exploiting the form of the projected stochastic discount factor. Our treatment is formulaic in that the real-world expectation can be synthesized from the prices of the risk-free bond, the asset, and options on the asset. The method is free of distributional assumptions, and we use it to study empirical questions related to (i) conditional probability of a disaster and return upside and (ii) spanning hypothesis in the Treasury market. We examine empirical consistency and show that our theoretical treatment is relevant. In essay 3: Based on data until the mid 2000s, oil price changes were shown to predict international equity index returns with a negative predictive slope. Extending the sample to 2015, we document that this relationship has been reversed over the last ten years and therefore has not been stable over time. We then posit that oil price changes are still useful for forecasting equity returns once complemented with relevant information about oil supply and global economic activity. Using a structural VAR approach, we decompose oil price changes into oil supply shocks, global demand shocks, and oil-specific demand shocks. The hypothesis that oil supply shocks and oil-specific demand shocks (global demand shocks) predict equity returns with a negative (positive) slope is supported by the empirical evidence over the 1986--2015 period. The results are statistically and economically significant and do not appear to be consistent with time-varying risk premia.
Essays on Market Microstructure and Asset Pricing
(2019) Hu, Bo; Kyle, Albert S; Loewenstein, Mark V; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains three essays that explore various topics in market microstructure and asset pricing. These topics include statistical arbitrage, algorithmic trading, market manipulation, and term-structure modeling. Chapter 1 studies a model of statistical arbitrage trading in an environment with fat-tailed information. I show that if risk-neutral arbitrageurs are uncertain about the variance of fat-tail shocks and if they implement max-min robust optimization, they will choose to ignore a wide range of pricing errors. Although model risk hinders their willingness to trade, arbitrageurs can capture the most profitable opportunities because they follow a linear momentum strategy beyond the inaction zone. This is exactly equivalent to a famous machine-learning algorithm called LASSO. Arbitrageurs can also amass market power due to their conservative trading under this strategy. Their uncoordinated exercise of robust control facilitates tacit collusion, protecting their profits from being competed away even if their number goes to infinity. This work sheds light on how algorithmic trading by arbitrageurs may adversely affect the competitiveness and efficiency of financial markets. Chapter 2 extends the basic model in Chapter 1 by considering an insider who strategically interacts with a group of algorithmic arbitrageurs who follow machine-learning-type trading strategies. When market liquidity is good enough, arbitrageurs may be induced to trade too aggressively, giving the insider a reversal trading opportunity. In this case, the insider may play a pump-and-dump strategy to trick those arbitrageurs. This strategy is very similar to those controversial trading practices (such as momentum ignition and stop-loss hunting) in reality. We show that such strategies can largely distort price informativeness and threaten market stability at the expense of common investors. This study reveals a list of economic conditions under which this type of trade-based manipulations are likely to occur. Policy implications are discussed as well. Chapter 3 provides a simple proof for the long-run pricing kernel decomposition developed by Hansen and Scheinkman (Econometrica, 2009). In a stationary Markovian economy, the long forward rate should be flat so that the pricing kernel can be easily factorized in a multiplicative form of the transitory and permanent components. The permanent (martingale) component plays a key role as it induces the change of probabilities to the long forward measure where the long-maturity discount bond serves as the numeraire. I derive an explicit expression for this martingale component. It reveals a strong restriction on the market prices of risk in a popular approach of interest rates modeling. This approach neglects the permanent martingale component and restricts risk premia in a way undesirable for model calibration. Further analysis demonstrates the advantages of equilibrium modeling of a production economy since it is featured with a path-dependent pricing kernel that has a non-degenerate permanent martingale.
ESSAYS ON INFORMATION PRODUCTION AND DIFFUSION IN FINANCIAL MARKETS
(2019) Collina, Stefano; Heston, Steven L; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains two essays that study the information produced by equity analysts and how the diffusion, or lack thereof, of this information affects financial markets. In the first essay, "Does the Precision of Equity Analysts Matter? Evidence from the Textual Content of Analysts’ Reports", I propose that analyst’s precision and opinion jointly explain a range of market outcomes, including returns, volume, and volatility, of the publication of an analyst report. I construct a novel measure of precision based on textual analysis of equity analysts’ reports. I find that for pessimistic reports, higher precision is associated with a significantly larger negative price reaction. Moreover, the higher precision is associated with higher abnormal turnover, higher volatility, and lower change in uncertainty. However, precision is not significantly or only weakly correlated with market reaction for optimistic reports. I argue that this dichotomy is a result of the well-known optimism bias of equity analysts and of a tendency of analysts to inflate the precision of more optimistic reports. I also show that the relation between precision and price reaction varies depending on the information environment and on textual characteristics of the analyst report. In the second essay, "Information Asymmetry, Agency Conflicts, and the Cost of Capital", I study the causal relation between information asymmetry and the cost of capital employing the exogenous increase in information asymmetry caused by the loss of equity analysts due to brokers’ closures or mergers, In particular, I focus on understanding how information asymmetry differentially affects the cost of debt and the cost of equity and how managerial and debt agency conflicts affect this relation. I find that an increase in information asymmetry results in higher cost of equity (debt) when the shock is greater and when incentives to engage in debt-equity wealth transfers are low (high). These results suggest that for some firms, differently from what usually assumed, the cost of debt can actually be more sensitive than the cost of equity. I argue that these findings are consistent with the hypothesis that an information asymmetry increase is not necessarily costly for shareholders, since it can facilitate debt-equity wealth transfers that can reduce equity risk.
Essays on Market Microstructure and Asset Pricing
(2017) Chen, Wen; Kyle, Albert S; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation contains two essays exploring the asset pricing implications of asymmetric information, hedging and market making. Chapter 1 studies position limits on strategic speculators in commodity futures. In this chapter I develop an equilibrium model with both spot and futures markets to evaluate the effects of speculative position limits proposed by commodity regulators. One of the main implications of this model is that the imperfectly competitive speculators can benefit from the limits at the expense of unconstrained market participants. Therefore, it is important to take into account the market competitiveness when setting position limits. I also find that the limits always reduce market liquidity and thereby increase the cost of hedging. Thus, position limits would benefit market makers but hurt hedgers. Moreover, the loss of liquidity due to the limits has a spillover effect on the spot market as futures prices reveal less information which makes all spot market participants worse off. Contrary to regulators' beliefs, the model suggests that an aggregate position limit may reduce speculators' competition and market liquidity even when the limit does not bind. The model provides an alternative explanation of magnet effect of position limits, which is imperfect competitive speculators tend to exert their market power to make the limits bind. Chapter 2 (joint with Yajun Wang) studies dynamic of market making and asset pricing. In this chapter, we develop a dynamic model of market making with asymmetric information where imperfectly competitive market makers match offsetting trades and carry zero inventory over time. Our model captures key features of market making in many financial markets: market makers optimally facilitate trading in both bid and ask markets by adjusting bid and ask prices and they hold close-to-zero inventories at the end of the day. We solve for equilibrium bid/ask prices and market depths in closed-form, and examine how informed traders dynamically hedge liquidity shocks and reveal private information. We further study the dynamics of bid-ask spread and trading volume to understand how these may interact with each other in shaping asset prices and market liquidity.
Essays in Corporate Finance
(2017) Hu, Xiaoyuan; Maksimovic, Vojislav; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation presents two essays about corporate finance, product market, and corporate governance. The first essay shows that, depending on product market structure, firms adjust executive compensation differently in response to shocks to firm risk. Using a natural experiment that increases firm risk due to discoveries of carcinogens, I find that treated firms increase CEO risk-taking incentives to mitigate underinvestment. This result is mainly driven by treated firms in less affected industries, which suggests that firms respond to shocks more strongly when fewer rivals face the same shock, and extends existing work on executive compensation adjustments based on industry-level analyses. The second essay provides evidence that the effect of product market competition on corporate performance depends on the overlap in customer base. Competition between firms supplying to a same customer mitigates the decline in firms' operating performance after the passage of a business combination law. This finding is more evident when the common customer is the only major customer or when firms produce specific inputs. In addition, competition between firms supplying to different customers has little effect on firm performance. These results highlight the impact of the structure of production cluster, defined as a group of same-industry firms that supply to a same customer, on corporate outcomes.
Essays in Corporate Finance
(2016) Bowen III, Donald Eugene; Faulkender, Michael; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation is comprised of three essays about investment, technology transfer, and corporate governance mandates. The first essay, “Patent Acquisition, Investment, and Contracting”, examines the transfer of intellectual property via the secondary market for patents and asks how patent acquisitions interact with firm investment policy. I find that patent acquirers subsequently invest in more R&D, increase internal patenting, and eventually make new investments in CAPX. Firms with more technological expertise and investment opportunities acquire more patents. Patent sales are the dominant type of contract and maximize investment incentives; patent licenses frequently contain royalties, which induce underinvestment problems. Nevertheless, licensing can be explained in part by financial and strategic considerations. Licensing is more likely when buyers become financially constrained, when revenue can be shifted to low tax sellers, and when the buyer is a competitor acquiring rights to a valuable patent. Overall, these results suggest patent acquisitions are motivated by the pursuit of investment synergies, rather than innovation substitution, commercialization motives, or legal threats. The second essay, “What's your Identification Strategy? Innovation in Corporate Finance Research”, co-authored with Laurent Fresard and Jerome P. Taillard, studies the diffusion of techniques designed to identify causal relationships in corporate finance research. We estimate the diffusion started in the mid-nineties, lags twenty years compared to economics, and is now used in the majority of corporate finance articles. Consistent with recent theories of technology diffusion, the adoption varies across researchers based on individuals' expected net benefits of adoption. Younger scholars, holders of PhDs in economics, and those working at top institutions adopt faster. Adoption is accelerated through networks of colleagues and alumnis and is also facilitated by straddlers who cross-over from economics to finance. Our findings highlight new forces that explain the diffusion of innovation and shape the norms of academic research. The third essay, “Were non-independent boards really captured before SOX?”, exploits the legal implementation of rules used by the major US stock exchanges following Sarbanes-Oxley (SOX) to study the pre-SOX optimality of board structure. The rules allowed firms to change the legal independence of their board without changing personnel by reclassifying a director from non-independent to independent. Many firms required to change their board structure used reclassification in order to minimize the alterations they made to their pre-SOX board structure, and I call these “placebo firms”. This observation makes feasible a DDD test that identifies the effect of the mandate by comparing treatment firms to placebo firms. Consistent with the view that boards are chosen optimally, real outcomes (profitability) are better for placebo firms than treatment firms. The magnitude of the difference, 4.9 percentage points, is economically meaningful, implying that the constraint is a significant impediment to the conduct of firms targeted by the regulations. Increased profitability is accounted for by increased revenue and typically flat expenses, including investment levels.
Essays in Corporate Finance
(2017) Duquerroy, Anne Nicole; Faulkender, Michael W; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation presents two essays in Corporate Finance. In the first essay, I study how political institutions affect corporate investment through the policy uncertainty channel. I examine investment response to changes in the ability of the governing party to implement its political agenda due to checks and balances. I use US gubernatorial elections from 1978 to 2010 and a regression discontinuity design to estimate the causal effects of giving a single party full versus split control over a state government. I find that shifts from a divided to a unified government depress investment and job creation. Investment drops by an average of 3 to 5 percent in the year after the election giving a single party control of the government. The effect is not limited to public firms, is stronger for firms operating in a single state and firms with more irreversible investment. The findings support the hypothesis that moving from divided to unified government translates into policy uncertainty, which in turn affects the investment and employment cycles. The second essay is joint with William Mullins and Christophe Cahn. How to support private lending to SMEs during aggregate contractions is a crucial but still open policy question. This paper exploits an unexpected drop in 2012 in the cost of funding bank loans to some firms but not others in France to uncover how banks adjust their SME lending portfolios in a crisis. The cost reduction causes bank debt to rise and payment defaults with suppliers to fall, providing evidence that funding cost can be an effective policy lever. The effect is driven by firms with only one bank relationship, a numerous but understudied group. The size of the effect varies, with additional credit flowing to firms with stronger observables, to high growth firms, to firms with high demand, and to firms with a deeper banking relationship. Further, a richer relationship appears to substitute for stronger observables in the lending decision. Finally, we provide suggestive evidence that, compared to multi-bank firms, single bank firms are particularly credit constrained in crisis periods.
Essays on Financial Constraints, R&D Investments, and Competition
(2016) Lin, Danmo; Mathews, Richmond D; Loewenstein, Mark; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of two chapters of theoretical studies that investigate the effect of financial constraints and market competition on research and development (R&D) investments. In the first chapter, I explore the impact of financial constraints on two different types of R&D investments. In the second chapter, I examine the impact of market competition on the relationship between financial constraints and R&D investments. In the first chapter, I develop a dynamic monopoly model to study a firm’s R&D strategy. Contrary to intuition, I show that a financially constrained firm may invest more aggressively in R&D projects than an unconstrained firm. Financial constraints introduce a risk that a firm may run out of money before its project bears fruit, which leads to involuntary termination on an otherwise positive-NPV project. For a company that relies on cash flow from assets in place to keep its R&D project alive, early success can be relatively important. I find that when the discovery process can be expedited by heavier investment (“accelerable” projects), a financially constrained company may find it optimal to “over”-invest in order to raise the probability of project survival. The over-investment will not happen if the project is only “scalable” (investment scales up payoffs). The model generates several testable implications regarding over-investment and project values. In the second chapter, I study the effects of competition on R&D investments in a duopoly framework. Using a homogeneous duopoly model where two unconstrained firms compete head to head in an R&D race, I find that competition has no effect on R&D investment if the project is not accelerable, and the competing firms are not constrained. In a heterogeneous duopoly model where a financially constrained firm competes against an unconstrained firm, I discover interesting strategic interactions that lead to preemption by the constrained firm in equilibrium. The unconstrained competitor responds to its constrained rival’s investment in an inverted-U shape fashion. When the constrained competitor has high cash flow risk, it accelerates the innovation in equilibrium, while the unconstrained firm invests less aggressively and waits for its rival to quit the race due to shortage of funds.
Essays in Corporate Finance
(2016) Starkweather, George Austin; Maksimovic, Vojislav; Faulkender, Michael; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Prior research has been divided regarding how firms respond to bankruptcy risk, largely revolving around two competing forces. On the one hand, asset substitution encourages firms to increase the riskiness of assets to extract value from creditors. On the other, firms want to minimize bankruptcy risk, either by reducing cash flow risk or through increasing the size of the firm. I test these two theories using a natural experiment of chemicals used in production processes being newly identified as carcinogenic to explore how firms may respond to potential negative cash flow resulting from litigation risk. I use plantlevel chemical data to study firm exposure to risk. I examine how responses between firms of differing levels of chemical exposure may vary within the industry, how firm financial distress affects firm response and whether public and private firms respond differently. In general, my research provides support for the asset substitution theory. My first paper studies how investment response varies based on level of carcinogenic exposure. I find that firms with moderate levels of exposure make efforts to mitigate their cash flow risk and reduce their exposure. At the same time, firms with high levels of exposure increase their exposure and riskiness of future cash flows. These findings are consistent with asset substitution theory. My second paper analyzes the interaction of financial distress and risk exposure. I find that firms in a stronger financial position are more likely to limit their exposure by reducing the number of exposed facilities. On the other hand, not only do firms in weaker financial position not decrease their exposure, I find that, in some instances, they increase their exposure to carcinogens. This work again supports the theory of asset substitution. Finally, in my third paper, I explore if public firms respond differently to a potential negative cash flow shock than do private firms. I test whether existing public firms are more likely to attempt to minimize their cash flow risk and thus reduce their carcinogen exposure than are private firms. I do not find evidence that public firms respond differently to this shock than do private firms.
ESSAYS ON MARKET MICROSTRUCTURE
(2015) BAE, KYOUNG HUN; Kyle, Albert S.; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation includes two essays on topics related to market microstructure. In the first essay, we analyze algorithmic trading in the Korean Index Futures market. We document that short-term traders consistently anticipate the order flow of large traders that build large positions within a short period of time. We study trade-by-trade data around 36,164 trades by large traders among the largest 1% of all active trades during 66 trading days in 2009 from the Korean Index Futures market. We find that large traders manage their orders first by executing small, positively correlated trades, which are followed by a single large trade. While the small trades are executed, short-term traders gradually increase their inventories in the direction of the forthcoming large trade. After the execution of the large trade, short-term traders unload their inventories to other traders. We find that short-term traders correctly anticipate the direction of large trades 56.06% of the time. Furthermore, the aggregate positions of short-term traders are statistically significant predictors for the direction of large trades that will arrive within 120 seconds. In the second essay, we explore market microstructure invariance in the Korean stock market. We define the number of buy-sell “switching points” based on the number of times that individual traders change the direction of their trading. Based on the hypothesis that switching points take place in business time, market microstructure invariance predicts that the aggregate number of switching points is proportional to the 2/3 power of the product of dollar volume and volatility. Using trading data from the Korea Exchange (KRX) from 2008 to 2010, we estimate the exponent to be 0.675 with standard error of 0.005. Invariance explains about 93% of the variation in the logarithm of the number of switching points each month across stocks.
Short-Term Funding Markets and Systemic Risk
(2015) Munyan, Benjamin Kendrick; Kyle, Albert S; Wermers, Russell R; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation presents two essays to study both theoretically and empirically the interaction of short-term funding and the banking system and its effects on systemic risk. Before its collapse in September 2008, Lehman Brothers had been using the repurchase agreement (repo) market to hide up to $50 billion from their balance sheet at the end of each quarter. When this "Repo 105" scheme was uncovered (a type of strategy called window dressing), the Securities and Exchange Commission conducted an inquiry into public US financial institutions and concluded that Lehman was an isolated case. Using confidential regulatory data on daily repo transactions from July 2008 to July 2014, in my first essay, I show that non-US banks continue to remove an average of $170 billion from the US tri-party repo market every quarter-end. This amount is more than double the $76 billion market-wide drop in tri-party repo during the turmoil of the 2008 financial crisis and represents about 10% of the entire tri-party repo market. Window dressing induced deleveraging spills over into agency bond markets and money market funds and affects market quality each quarter. Demand deposit contracts provide liquidity to investors; however by their nature they can expose the issuer to self-fulfilling runs. Existing models treat depositors as agents facing uncertain liquidity shocks, who seek to insure against that liquidity risk through use of a bank financed solely by deposits. Welfare-reducing bank runs then arise from the inherent difficulties depositors face in coordinating their withdrawals. My second essay extends the classic model of Diamond & Dybvig (1983) to allow for a more realistic mixed capital structure where the bank's investments are partly financed by equity, and where differing incentives between shareholders and depositors are allowed to operate. I also further extend the model to allow shareholders to choose the level of risk in bank-financed projects. I compute the ex-ante probability of a bank run in consideration of the bank capital ratio, and I additionally compute the level of bank risk chosen by utility-maximizing shareholders who are disciplined by uncoordinated depositors. I find that even in the absence of bank negotiating power of the form in Diamond & Rajan (2000), banks can be welfare-improving institutions, and there exists a socially optimal level of bank capital. I consider the policies of a minimum capital requirement, deposit insurance, and suspension of convertibility, and provide guidance on creating optimal bank regulation. I show that the level of bank capital involves a tradeoff between sharing portfolio risk and sharing liquidity risk. Increased bank capital results in less risk-sharing between shareholders and depositors. The demand deposit contract disciplines the bank and its shareholders, and equity capital in effect disciplines the depositors (by making runs less likely). There is a socially optimal level of natural bank capital, even when I make no further social planner restrictions on bank portfolio choice in the model.
Essays on Asset Pricing and Financial Stability
(2014) Lee, Jeongmin; Kyle, Albert S.; Loewenstein, Mark; Business and Management: Finance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
My two-essay dissertation revolves around understanding the financial crisis of 2008. First I focus on the repo market, a major funding source of the shadow banking system, and show the repo market can create and amplify the fragility of the system. Then I investigate a broader economy with heterogeneous agents and demonstrate how the dynamics of equilibrium asset prices and wealth distributions are determined. In Essay 1, I develop a dynamic model of collateral circulation in a repo market, where a continuum of institutions borrow from and lend to one another against illiquid collateral. The model emphasizes an important tradeoff. On one hand, easier collateral circulation makes repos liquid and increases steady state investment through several multiplier effects, improving economic efficiency. On the other hand, it can harm financial stability because less capital is sitting on the sidelines waiting for investment opportunities. This fragility is further exacerbated by the endogenous repo spread through a positive feedback loop, and can result in an inefficient repo run. The model is relevant for understanding the repo markets during the financial crisis of 2008. In Essay 2, I study the dynamics of the wealth distribution and asset prices in a general equilibrium model. Agents face heterogeneous portfolio constraints that limit the shares of risky investments relative to wealth. The setup is motivated by empirical evidence that many households do not participate in the stock market and portfolio shares are heterogeneous and persistent conditional on stock market participation. There are two main results. First, one state variable can summarize the wealth distribution regardless of the number of types of agents. Second, when the economy is bad, it becomes more sensitive to additional negative shocks, meaning that not only magnitudes of the shocks but also their frequency matters.