Essays in empirical asset pricing

Abstract

I study questions related to risk premia in international equity markets and broad asset classes,and the role of financial intermediaries – market makers (dealers) and institutional investors – inshaping the price dynamics. This thesis consists of four essays.In the first essay, we study the importance of foreign institutional investors in the capital alloca-tion process worldwide. we find that stocks that are held more by foreign institutional investorshave more informative prices unconditionally and conditional on the samelevel of local institu-tional ownership. Foreign investors contribute to price informativeness about as much as localinvestors, especially for stocks in non-U.S. countries. The magnitude of the effect is robust tovarious endogeneity concerns.In the second essay, we use a unique transaction-level dataset on over-the-counter foreign ex-change derivatives – forwards, swaps and cross-currency swaps – to study the failure of textbookno-arbitrage condition in FX markets, the covered interest rate parity (CIP). Empirically, weshow that the newly introduced regulatory requirement on the balance sheet contributes to theviolation of CIP. We solve the endogeneity issue by using an exogenous variation arising from theimplementation of UK leverage ratio framework.In the third essay, we construct a strategy that buys securities with low past overnight returns andsell securities with high past overnight returns generates sizeable out-of-sample excess returns andSharpe ratios. This strategy outperforms the conventional short-term reversal strategy for majorinternational equity markets and futures written on equity indices, interest rates, commodities,and currencies. we find that the cross-sectional return volatility explains the returns from thisstrategy consistent with time-varying limits to arbitrage. In contrast, traditional risk factors failto price these excess returns.In the last essay, we carry out the first cross-country analysis of the correlation risk premium.we examine the statistical properties of the implied and realized correlation in European equitymarkets and relate the resulting premium to the US equity market correlation risk and a globalcorrelation risk factor. We find evidence of strong co-movement of correlation risk premia inEuropean and US equity markets. The results support the hypothesis that a global correlationrisk factor exists and that it is priced in international equity optionmarkets. Finally, we documentthe relationship between the correlation risk premium on macroeconomic policy uncertainty andother uncertainty measures.