Finance - Theses

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    Market microstructure and stock returns
    Sun, Jiamu ( 2023-07)
    Abstract This thesis explores the mechanisms that connect market microstructure frictions and stock return dynamics. It contains one literature review and two essays. The literature review provides a systematic introduction of the most important theoretical models and empirical methods in market microstructure literature, with a particular focus on their relations to the traditional asset pricing literature and implications for the stock price dynamics. It aims at providing the background information for the two essays and connecting them under a unified theme. The first essay documents the closing price premium (negative overnight return at individual stock level) in China’s A-share market, which reflects the preference of buying at the close for liquidity reasons induced by the unique T+1 settlement rule that requires stocks bought can only be settled and sold on the next trading day. Liquidity providers can use short-selling to circumvent the T+1 settlement rule and facilitate intraday round-trip trade. This study provides causal evidence showing that the closing price premium is reduced when the short-selling constraint gets relaxed. It shows that the bid-ask spread gets smaller with the closing premium reduction, a sign of liquidity improvement. This study enriches the short-selling literature and understanding of China's capital market microstructure by emphasizing how short-selling can aid in inventory management and mitigate mispricing due to regulatory frictions, such as the T+1 settlement rule. The second essay studies the stock return predictability from lagged order imbalance (OI) and its causes. It shows that the direction of the OI-based return predictability is time-varying instead of always being positive, as documented in Chordia and Subrahmanyam (2004). Two offsetting forces affect the predictability. First, a negative “inventory effect” in which the stock price reverses current price pressure as compensation for the liquidity provider's inventory risk. Second, a positive “order-splitting effect” where autocorrelated order imbalances and continuous price pressure are caused by the practice of investors splitting orders to minimize price impact. It presents empirical evidence supporting this view. The coefficient representing the sign and strength of the OI-based return predictability is larger for stocks with more institutional trading and smaller for stocks with less liquidity and higher inventory risk. Market-level analysis shows a distinct synchrony between the time series of the predictability coefficient and the VIX (the proxy for the inventory effect). This study offers an updated view of daily stock return predictability based on order imbalance and deepens the understanding of the mechanisms behind daily stock price dynamics by examining market microstructure factors, including strategic behaviors of investors with large liquidity demand and the liquidity provider’s inventory management practices.
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    Essays on Dual Ownership
    Wu, Lin ( 2023-10)
    This thesis explores the phenomenon of dual ownership, where investors hold both equity and debt in a firm simultaneously. Dual ownership has garnered significant attention in finance due to its potential to align the interests of shareholders and debtholders, mitigating agency costs and enhancing firm governance. This thesis aims to bridge gaps in the existing literature by investigating a relatively unexplored measure of dual ownership and concerning the potential drawbacks of the presence of dual holders. Chapter 3 of this thesis delves into the often-overlooked area of indirect dual ownership, comprising shareholders who simultaneously hold both equity and indirect debt through commercial banks, a major participant in the loan market. While previous research has mainly focused on non-commercial banking dual holders, this study recognizes the significance of indirect dual holders, given their rising prominence and representation as two-thirds of lead lenders in syndicated loans. Investigating the impact of indirect dual holders on creditor control rights and firm performance following covenant violations, the findings reveal that firms with indirect dual holders experience less creditor intervention and demonstrate better operating performance, resulting in positive abnormal returns. In contrast, banks with indirect dual holders show negative abnormal returns, indicating potential signalling effects. However, the overall portfolio of indirect dual holders has positive abnormal returns, suggesting they have net gain through dual holding. The insights from this chapter underscore the importance of considering indirect dual holders in the syndicated loan market and provide valuable contributions to understanding the multifaceted implications of dual ownership on firm behaviour and performance. Chapter 4 investigates the impact of dual ownership on conflicts between lead lenders and participant lenders within syndicated loans. The study finds that the lead lender's equity stake in the borrowing firm increases the lead-participant conflict, while participants holding equity decrease the conflict. Additionally, (potential) lenders with an equity stake in the borrower are more likely to join the syndicate, suggesting the lead lender's preference for lenders with less conflict of interest. Chapter 5 analyses the optimality of debt contracts and the managerial incentive mechanism design in the presence of dual holders. The study introduces a capital structure model with dual-holder investors who hold both debt and equity. Dual holders' reduced incentive to liquidate the firm compared to pure debtholders necessitates adjustments to the optimal debt level to induce managerial effort. This thesis makes valuable contributions to the existing literature, providing insights into the significant role of indirect dual holders, the impact of dual ownership on conflicts within syndicated loans, and the impact of dual holders on managerial incentive mechanisms. The findings have implications for corporate governance practices and policymaking, offering guidance to financial institutions, corporations, and investors. By addressing the overlooked aspects of dual ownership, this research enhances our understanding of its complexities and implications for firm behaviour and performance.
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    Essays on Mutual Funds
    Luo, Haoyi ( 2023-09)
    In this dissertation, I look into two significant questions within the broader scope of mutual funds. Firstly, I examine the external effects of a substantial increase in mutual fund ownership in public companies. Secondly, I investigate the comparative abilities of mutual fund managers. These investigations are conducted through two separate essays, Chapter 3 and Chapter 4, where empirical studies are undertaken within the context of U.S. index funds and Chinese fixed income funds, respectively. Chapter 3 focuses on addressing the following research questions: Does the inclusion in index fund portfolios have a positive impact on information disclosure of public firms? Additionally, does securities lending enhance or offset this impact? In Chapter 4, in collaboration with my co-author, I endeavour to explore the following research questions: Do managers with a background in credit rating outperform their non-analyst counterparts in the management of fixed income mutual funds? If so, is this outperformance attributed to superior credit rating-specific skills or the acquisition of superior information through networks? The first essay, presented in Chapter 3, looks into the impact of both investment and lending activities of index funds on information disclosure of public firms. The study focuses on a sample of U.S. firms spanning from 2002 to 2017. Notably, the research reveals contrasting effects: securities lending is found to have a detrimental impact on the information environment of public firms, while index fund holdings are associated with improved information transparency and a decrease in the withholding of negative news by company managers. These findings remain robust across various tests and are particularly pronounced when examining a smaller sample utilizing the Russell 1000/2000 index reconstitution as a source of exogenous variation in index fund holdings. Additionally, the study uncovers a negative relationship between index ownership and abnormal trading activities during weeks of stock price crashes. These results support the notion that despite their prevalent securities lending and passive investing strategies, index funds have an overall positive influence on the information environment of public firms. The second essay, presented in Chapter 4, aims to examine whether bond fund managers who possess credit rating experience outperform their counterparts. The study provides evidence that, on average, bond fund managers with prior employment in credit rating agencies generate higher risk-adjusted returns than their peers. Specifically, their performance surpasses that of their counterparts by 11-16 basis points per month, indicating superior security selection and market timing abilities. Moreover, the study confirms that this outperformance stems from their industry-specific knowledge acquired through credit rating experience (specialization), rather than any informational advantage derived from their previous colleagues (network). Additionally, the study reveals net inflows to funds managed by these managers, suggesting that investors are aware of the skills possessed by analyst managers.
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    Essays in Corporate Finance
    Hu, Muhan ( 2023-07)
    This thesis explores the determinants and effects of corporate innovation and technology spillovers, emphasizing their roles in productivity and economic gains. It contains a literature review and two essays examining different aspects of finance at its intersection with innovation. The first essay investigates how competition affects the economic value of innovation, the primary incentive for corporate R&D investments. I measure the economic value of innovation based on the changes in patenting firms' stock market value around patent issuance dates, following Kogan et al. (2017). The economic value of innovation is higher in industries with a low level of competition. Within an industry, firms at the technological frontier or those with relatively high pricing power enjoy higher economic returns from patents. I use a quasi-natural experimental design to compare the value of patents issued immediately before and after competition-altering events. Using horizontal M&A announcements as anti-competitive events, I show that an expected decrease in market competition leads to increased patent value. In the second essay, Lyndon Moore and I study technology diffusion mechanisms using a unique historical setting: the introduction of the cyanide method of gold extraction on the Witwatersrand goldfields in the late 19th and early 20th centuries. Mines managed by the same mining house were more likely to adopt the new process, which increased extraction rates by around 50%. Cyanide technology was continually improved after its introduction. We find evidence of "technological know-how" spillovers from engineers and mine managers but not white-collar employees. Geographical spillovers are extremely localized in nature.
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    Essays on the Political Economy of Finance
    Ma, Linxiang ( 2023-07)
    This thesis investigates corporate finance issues through the lens of political economy. It explores the relationship between politics and business in China, focusing on the politicians' influences on the corporate sector. The study contains two essays that examine different channels through which politicians exert their impact: policy-making and physical activities. The first essay studies whether political ideology motivates economic decisions in authoritarian regimes. Using a novel ideology measure, I document that during China's privatization wave, a provincial governor's communist belief substantially reduces the privatization intensity in his province. In contrast, a provincial party secretary's ideology only has a moderate indirect impact. Moreover, firms privatized under more communist-minded governors achieve lower post-sale efficiency improvements. In contrast, a party secretary's ideology does not influence post-privatization efficiency. The second essay examines how politicians' activities affect the stock market and firm performance. I investigate how China's national leaders' firm visits affect other firms in the visited industries. I find that, for industry peers, these visits have a positive value impact in the short run but a substantial negative performance impact in the long run. Further analyses reveal that industry peers increase their investments after the visits, presumably in anticipation of additional government subsidies and credits. However, these resources are never delivered, and consequently, the profitability of these firms falls.
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    The Role of Fee Structure in Mutual Fund Management
    Xu, Zijin ( 2023-07)
    Mutual funds have become an increasingly popular investment vehicle over the past few decades, with a wide range of options available to investors seeking exposure to various asset classes and investment strategies. However, one of the key factors that investors must consider when choosing a mutual fund is the fees charged by the fund manager. These fees can have a significant impact on an investor's returns over time, and yet they are often poorly understood or overlooked altogether. The purpose of this thesis is to provide a comprehensive analysis of mutual fund fees and their impact on investor returns. This research focuses on the relationship between fees and fund performance, as well as the factors that influence fee levels and how they are disclosed to investors. Chapter One introduces the topic of mutual fund fees, outlining the key research questions and objectives of the study. This chapter also presents a discussion of the various types of fees charged by mutual fund managers. Chapter Two presents a review of the existing literature on mutual fund fees, including both theoretical and empirical research. This chapter provides a critical evaluation of the key theories and models that have been used to analyse mutual fund fees, as well as a summary of the most significant empirical findings in this area. The chapter also identifies gaps in the current literature and sets out the research questions that will be addressed in the subsequent chapters. Chapter Three examines one specific family-level strategy: the loss-leader pricing strategy. In this chapter the discussion is rooted in the question of why do fund families price low some of its member funds. Anecdotal evidence suggests this is due to flow incentives. This chapter provides systematic evidence that supports the existence of strategic pricing and finds rich pattern that fund families are leveraging pricing strategies to maximize family-level benefit. The flow incentive of fund families is reflected by the choice of loss-leader funds and fund-level inflows. Chapter Four gauges how much do fund families and investors care about fund fees by investigating an event study surrounding an SEC policy change. The policy change imposes different level of effect to different share classes of the same fund. The exogenous event provides an opportunity to separate the flow reaction to changes in fees and performance since all share classes of the same fund share the same before-fee risk adjusted returns and differ only in the fee structure. Chapter Four serves as an extension to Chapter Three in that it investigates more deeply into the dynamic of fee, flow and performance. In one aspect, this study adds to the mutual fund literature by introducing the concept of family-level strategic pricing. It challenges the traditional focus on individual fund-level pricing and provides insights into how mutual fund families strategically set prices to influence investor flows. This approach builds on previous research while addressing a gap in the literature by examining the motivations and dynamics behind family-level pricing decisions. It emphasizes that fund families often manage multiple funds with varying performance levels, optimizing fees collectively rather than for individual funds, which has implications for resource allocation and benefits for fund families. In another dimension, the study explores how investors consider mutual fund fees in their investment decisions. It references early research highlighting the impact of fees on investor behavior and includes trading costs as a significant component of a fund's total expenses that can affect fund flows. Additionally, it contributes to the literature on the relationship between mutual fund performance and flows, considering the asymmetric nature of this relationship. What sets this study apart is its inclusion of management fees and operating expenses in the performance-flow sensitivity analysis, emphasizing the direct link between fees and performance and their indirect influence on investor behavior. These insights offer a valuable perspective on the role of fees in shaping investor decisions within the mutual fund industry. Overall, this thesis aims to contribute to our understanding of mutual fund fees and their impact on investor returns. By providing a comprehensive analysis of this important issue, this research can help investors make more informed decisions about their mutual fund investments and can also inform policymakers and regulators as they seek to ensure that the mutual fund industry operates in a fair and transparent manner.
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    Essays on Blockholder and Corporate Finance
    Huang, Sheng ( 2023-05)
    This thesis explores the multifaceted role of large shareholders ("blockholders") in a firm. There has been an exponential growth of the asset management industry in the last few decades, giving rise to more non-controlling blockholders in the firm. Such blockholders are important in corporate governance because the large stakes they hold incentivize them to monitor the firm. Given blockholder's importance, it is critical to understand what determines blockholder's presence. On the other hand, the evidence of blockholder's impact on firm outcomes has been mixed in the literature. This thesis helps shed light on both the determinants and impacts of blockholders in a firm. The first essay investigates how CEO incentives, i.e., the sensitivity of the CEO's wealth to firm value, affect blockholder monitoring. CEO incentives can both 1) complement blockholder monitoring by punishing the CEO harder when a dissatisfied blockholder exits, and 2) substitute blockholder monitoring by reducing the CEO-shareholder conflict. I model the relation between managerial incentives and blockholder monitoring and show the substitution effect dominates. I also find empirical evidence of the substitution effect: blockholding in a firm is lower when CEO incentives are higher, and this negative relation is stronger in firms where blockholders are there to monitor. In the second essay, I look at how a firm's covenant violations affect blockholders' stakes in the firm. After covenant violations, creditors have more control over the firm by renegotiating debt contracts. It has been documented that creditors use the increased control to help turn around the firm. I find that blockholders have higher stakes in a firm after its covenant violations, consistent with the notion that blockholders try to gain from a firm's recovery. Blockholders who lack the ability to maximize value on their own are more likely to take the chance to gain from the recovery. Consistently, I find that blockholders who are experienced in governance activities are less likely to have higher stakes after covenant violations. In the third essay, which is a joint work with Yifan Zhou, we find that blockholders are positively associated a firm's crisis recovery. We discover that during the 2008-09 Global Financial Crisis, blockholders were associated with i) more votes against manager-initiated proposals, ii) a higher probability of appointing a new CEO and/or director, and iii) issuance of less net debt. These firm decisions are in turn associated with superior post-crisis performances.
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    Human, Artificial Intelligence and Tail Risk
    Huang, Shijie ( 2022)
    I study learning efficiency of artificial and human agents in the environment of financial markets. One prominent feature that distinguishes this environment is tail risk, which means that outliers are more frequent and substantial relative to Gaussian outliers. Failure to account for tail risk deteriorates learning efficiency, causing agents to derail from optimal actions. In the dissertation, I explore improvements to learning by artificial agents under tail risk, and whether human learning exhibits similar improvements. Finally I study to what extent agents' interactions and intelligence level would cause or amplify tail risk. A key success of artificial intelligence has been reinforcement learning. I first show that even the most advanced reinforcement learning protocol yields sub-optimal behavior in an environment with tail risk. Inspired by the concept of statistical efficiency, I propose a solution that nicely complements a recent protocol -- distributional reinforcement learning -- and improves the performance of algorithms. I show that the proposed algorithm learns much faster and is robust once it settles on a policy. Thus, efficiency gains are possible for artificial agents. Do humans exhibit the same kind of adjustment in an environment of tail risk? In the second study, I design an experiment to examine whether and how efficiency concerns drive human learning of stochastic rewards. While I find substantial heterogeneity, overall the answer is affirmative. Efficiency gains translate into enhanced choice confidence, except when participants fail to discover the most efficient estimator. In finance, the real causes of tail risk remain elusive. One conjecture is that, even without triggers from any extreme event, tail risk emerges because of agents' interactions in the marketplace. Motivated by the zero-intelligence and machine learning literature, I propose a paradigm to approach this conjecture in the third study. The paradigm comprises a single-widget economy, a continuous open-book market, and a group of trading agents with different intelligence levels. I demonstrate that trading generates excessive tail risk even when the underlying economic shifts follow a Gaussian law. Introducing a profit-seeking market maker further increases leptokurtosis, but the tail risk is not worsened. The latter suggests that tail risk and leptokurtosis may need to be distinguished.
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    New Approaches of Utilizing Firm Characteristics in Empirical Asset Pricing
    Wang, Mengchuan ( 2022)
    Firm characteristics carry very important information about stock prices and can be widely used in various aspects of asset pricing. This thesis contains 3 new applications of firm characteristics combined with some new technologies, which brings new understandings to several important questions: In chapter 3, my co-authors and I apply the General Empirical Likelihood (GEL) estimator to ask and answer the question of, which characteristic-sorted portfolios provide valuable information about the stochastic discount factor (SDF). We estimate a non-parametric SDF from a set of portfolios, then test whether excluding a portfolio changes the implied SDF. Though related to traditional asset pricing tests, our approach has several advantages: we test all portfolios jointly and can incorporate trading costs easily. We show four portfolios provide independent information about the SDF after accounting for trading costs: the Market and Profitability factors, an Investment-based portfolio, and the Value-Momentum-Profitability anomaly portfolio. The remaining portolios are redundant. We show both the joint testing and transaction cost adjustments are important for inference, and provide a simple way to implement our tests. In chapter 4, I introduce a Machine Learning (ML) based approach to construct comparable groups that researchers often use to compute the abnormal part of stock returns. The characteristics shown in chapter 3 to be important to asset pricing are included in this study as candidate characteristics. In order for stock expected returns to be similar within groups and disperse across groups, I use the ML based approach to select characteristics that best distinguish expected returns, and cutoffs points where returns are most sensitive to the underlying characteristics. I show that: 1) the combination of chosen characteristics changes over time; 2) fewer fund managers are identified to be stock pickers once the time-variation in comparable groups is incorporated; 3) and the resulting portfolios exhibit desirable properties as basis assets. In chapter 5, I adopt the ML based comparable groups from chapter 4 to analyze the market timing and stock picking skills of actively managed mutual funds. Compared to traditional studies which are prone to model mis-specification due to the difficulties in handling large dimensions and non-linearity, my approach can extract information about returns from a large number of characteristics, and allows for complex and time-varying relations between stock returns and firm characteristics. To the contrary of the consensus in prior literature, I find strong evidence in support of fund timing skills. On average, funds exhibit significantly positive timing performance. Cross-sectionally, the best timers continue to outperform others for at least three years after the ranking period. There is some picking return for the average fund but out-performance in picking does not persist. These results have real-world implications. I further show that investors can use my timing measure to identify funds with high future risk-adjusted performance.
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    Computational complexity of decisions: Quantifying computational hardness and its effects on human computation
    Franco Ulloa, Juan Pablo ( 2021)
    Humans are presented daily with decisions that require solving complex problems. In many cases, solving these problems is computationally hard. This raises a tension between the computational capacity of the agent and the computational requirements of a task. Whilst the underlying invariants of this mechanism remain unclear in cognition, they have been widely studied in computer science. I build on theoretical and empirical work in computational complexity, which characterizes the intrinsic computational hardness of problems. I first present an adaptation of this theoretical framework for the study of human cognition by introducing a set of metrics of hardness of instances of problems. I do this in a way that is independent of any algorithm or computational model and that can be generalized to other problems. Based on this, I explore empirically, in a set of lab experiments, how these task-independent metrics of hardness affect human problem-solving. I do this at two levels of analysis. Firstly, I study how these metrics affect human performance at the behavioral level in three canonical computational problems: the knapsack problem, the traveling salesperson problem and the Boolean satisfiability problem. Secondly, I examine the relation between computational hardness and the neural processes associated with problem-solving, employing ultra-high field functional MRI. I find that the metrics of intrinsic hardness put forward here predict human performance and time-on-task across the three computational problems in a similar way. Moreover, I identify the neural correlates of computational hardness in the knapsack task, a complex problem-solving task. I show that this framework can be used for the study of the neural underpinnings of problem-solving by providing a generic definition of cognitive demand. The results of these studies provide support for the conceptual premise that the quantification of intrinsic hardness is fundamental in the development of more refined theories of human decision-making and its neural underpinnings. Critically, they provide a framework to study how humans adapt to computational complexity and how intrinsic hardness of tasks affect the reliability of human decision-making. This could inform public policy by identifying which decisions over products involve solving problems that require computational resources beyond those available to an agent, and how this affects decisions.