This dissertation consists of three chapters that concern risk management and financial econometrics. Fannie Mae and Freddie Mac’s implicit government guarantee is widely argued to cause irresponsible risk taking. Despite moral-hazard concerns, this paper presents evidence that Fannie Mae and Freddie Mac (the GSEs) more effectively managed home price risks during the 2000-2006 housing boom than private insurers. Mortgage origination data reveal that the GSEs were selecting loans with increasingly higher percentage of down payments, or lower loan to value ratios (LTVs), in boom areas than in other areas. Furthermore, the decline of LTVs in boom areas stems entirely from the segment insured by the GSEs only, and none of the decline stems from the segment co-insured by private mortgage insurers. Private mortgage insurers also did not lower their exposure to home price risks along other dimensions, including the percentage of high LTV GSE loans they insured. To quantify how the GSEs’ portfolios would have performed under alternative home price scenarios, I build an insurance valuation model based on competing-risk hazard regressions, calibrated Hull and White term-structure model, and forecasting prepayment and default speeds. I find that the GSEs’ risk management would have been sufficient for the historically average 32% mean reversion but insufficient for the realized 95% mean reversion between 2006 and 2011. My results highlight that post-crisis reform of the mortgage insurance industry should carefully consider additional factors besides moral hazard, such as mortgage insurers’ future home price assumptions.

The second chapter studies high dimensional time series, with application to estimating the mean variance frontier. One persistent challenge in macroeconmics and finance is how to draw inference from data with a large cross section but short time series. Financial econometric techniques all are designed for large time series and small cross-sections. However, financial data typically has a large cross section and short time series (large-N small-T). One particular large-N small-T impact is the underestimation of risk in the mean variance frontier. We propose a correction for the finite sample bias when the underlying returns are high dimensional linear time series. Our algorithm first corrects for the bias in eigenvalues of the asset return covariance matrix, and then estimate the contribution of each leading factor to the mean variance frontier. A cross validation method is employed to select the optimal number of leading factors. Performance of the proposed methods is examined through extensive simulation studies.

The third chapter studies how expected home prices affect borrowers’ default behavior. One of the penalties mortgage defaulters face is being locked out of the mortgage market and missing the home price appreciation. I find that this penalty deters some borrowers from defaulting. A higher future home price growth implies a lower ex-ante default probability. Furthermore, high credit score borrowers react more to past home price declines and future home price appreciation than low credit score borrowers. This suggests that high credit score borrowers are more likely to be strategic defaulters. A model is built to study the effect of changing the cooling off period. In high expected home price appreciation areas, a longer cooling-off period amplifies the impact of each foreclosure. In low expected home price appreciation areas, a longer cooling-off period reduces the number of foreclosures.

This dissertation consists of two chapters centered on the interplay between financial markets and labor market institutions, and that emphasize how this interplay affects group inequality (i.e., inequality with respect to race, gender, socioeconomic status, etc.). Two main themes are recurrent in this work: (i) that firms' and lenders' distress risks spillover to workers and households; and (ii) that, conversely, frictions or interventions in the labor market create financial distortions. Taken together, these two ideas imply that the relationship between financial and labor markets can generate instability, as their reciprocal feedback tends to generate responses that are either cyclical or that amplify existing market frictions. Furthermore, by focusing on interventions in either labor or financial markets, this dissertation speaks to the distributional implications of this type of instability. In each of the chapters, we first rely on careful institutional analysis of the labor and financial forces at play (and their connection to macro labor and financial markets), and then proceed to use reduced form methods to assess the substantive economic questions of interest arising from those settings.

In the first chapter, ``Incarceration and Access to Credit," we evaluate the effects that carceral institutions have on access to credit, how incarceration obscures the information lenders use to screen borrowers, and how lack of access to credit impacts recidivism. When individuals are incarcerated, they lose their jobs and their ability to repay debts is impaired while in prison. These effects directly impact their ability to get credit. In addition to that, however, it creates an information problem for lenders, as they are unable to recover the true default probability of a formerly incarcerated loan applicant. Lenders can partially correct for information distortions if they are aware of an applicant's criminal record, but this correction would be incomplete: Lenders cannot recover distortions due to heterogeneity in the effects of incarceration, neither can they completely correct on average as they cannot distinguish among different types of sentence.

The case of incarceration highlights how a labor market institution can amplify information asymmetries problems present in the allocation of credit. But it also highlights a feedback effect: the interplay between the credit market and labor market amplifies a failure of the criminal justice institution to reduce crime, namely that incarceration increases individuals' likelihood of recidivism. We show that when individuals are unable to access durable goods or smooth consumption due to credit frictions they are more likely to engage in criminal activity. But this effect is even stronger when the lack of access to credit stems from incarceration itself.

In the second chapter, ``How Corporate Debt Perpetuates Labor Market Disparities?," we take a new approach to address an old but important question: what drives the large magnitude of fluctuations in employment? Previous work has focused on explaining wage rigidities by exploring variations in the wage determination process, by studying labor institutions, or by studying cultural norms. We study, instead, the role corporate debt plays in determining equilibrium wages and unemployment. The idea is simple: a worker's wage reflects the job security of her employment match \textit{vis- a-vis} how valuable the outside option of being unemployed or working for another firm is. When aggregate financial leverage increases, it affects both components in conflicting directions: (1) unemployment risk goes up and, consequently, the firm must increase wages to keep the worker; and (2) the value of the outside option goes down, driving wages downwards, as unemployment risk increases for other firms as well.

When economic conditions are poor (i.e., low labor market tightness), the outside option of the worker is weak, which means that wages are mostly determined by the value of employment. In this case, increases in aggregate financial leverage resulting in higher unemployment risk decrease the future value of employment and since there is no offsetting effect through the outside option, wages must go up--- and so will unemployment. In constrast, when economic conditions are good (high labor market tightness), the outside option of the worker is high. This means that when aggregate financial leverage increases, any increase in wages resulting from higher unemployment risk will be offset by decreases in the outside option of the worker since unemployment risk is affecting other firms as well. Wages will go down--- and so will unemployment. The three take-aways on the dynamics of capital structure, wages, and unemployment are these: (1) leverage dampens fluctuations in wages (wages go up when economic conditions are poor, and vice versa); (2) leverage amplifies unemployment fluctuations (unemployment goes up, when it is already high, and vice versa); and (3) labor market tightness predicts changes in leverage.

Since the trade-off between compensation for unemployment risk and a weaker outside option arises from a general equilibrium framework, this paper can reconcile seemingly conflicting evidence in Corporate Finance. In an influential paper, Matsa (2010) finds that collective bargaining agreements lead to higher financial leverage. The finding, which has been documented in several other settings as well, has been interpreted as evidence of strategic use of corporate debt as a bargaining tool. However, Graham and Harvey (2002) provide survey evidence that CFOs give very little weight to bargaining with workers when making capital structure decisions. Our work reconciles both findings. Policies that affect the outside option of the worker will have an impact on capital structure. As we discussed, a higher outside option means that increases in the aggregate financial leverage will decrease wages leading to higher financial leverage in equilibrium. Leverage does affect bargaining with workers but it does not need to operate in a strategic manner.

The fact that stronger outside options lead to higher levels of financial leverage and that capital structure amplifies fluctuations in unemployment has important redistributive implications. When increases in the cost of labor are a result of employment regulations, the outside option of the worker increases and in equilibrium firms issue more debt, mitigate the regulatory costs, and weaken the regulation's intended objectives by increasing unemployment risk. Consistent with this, we find that firms increased corporate debt following the passage of anti-discrimination regulation during the Civil Rights Movement. We document that increases in corporate debt disproportionately exposed minority workers to higher levels of unemployment risk.

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