Finance Theses and Dissertations

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    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.
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    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.
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    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.
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    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.
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    (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.