Essays in Financial Economics and Industrial Organization
- Author(s): Studart, Marcus Eduardo Mathias
- Advisor(s): Weill, Pierre-Olivier
- Tornell, Aaron
- et al.
This essay consist of three chapters.
In chapter 1, I analyze the equilibrium behavior of asset prices and margins (i.e collateral required to trade shares using debt), when Market Makers smooth out price fluctuations by trading on a margin. I address the questions of 1) whether financial margins can increase in reaction to supply shocks without misinformation about the shocks' nature, 2) when non-fundamental shocks reduce asset prices and increase margins, and 3) how margins and prices react to persistent supply shocks, as opposed to temporary ones.
In the model, price fluctuations are induced by supply shocks, and margins are set to match the price depreciation induced by a future negative tail shock. Temporary shocks (i.e. shocks that fade very soon) are shown to have no effects on prices or margins, when either they are small or Market Makers hold large collateral amounts. If the shock is sufficiently large, some shares will be held by (currently active) risk averse investors, and price falls due to larger risk premium. If, before the shock, Market Makers were holding asset shares, prices fall even more, because Market Makers wealth is marked down, and expected future prices falls, since it becomes more likely that future shocks will depress prices. Persistent shocks (i.e. shocks that do not fade quickly) reduce current prices, because, in the best scenario, they shift down the future price distribution, and reduce Market Makers' asset valuation. I give conditions for margins to increase with a persistent shock. Falling prices and higher margins are not necessarily the result of a margin spiral (i.e. when margins increase and constrain Market Makers, who are forced to sell, causing prices to fall and margins increase more). Margins can increase because future price variance increases at the same time as Market Makers' asset valuation reduces, and Market Makers may not be financially constrained at all.
In chapter 2, I study repurchase agreements, short-term collateralized loans known as repos, that are commonly used to fund different sorts of assets. Using a dataset of Money Market Mutual Funds (MMF), I find that repos backed by liquid collateral, such as US Treasuries securities, have on average shorter maturities, lower haircut rates and lower interest rates than less liquid collateral, while the average maturities of repos held by MMF are positively correlated with fund size and overall portfolio maturity. Motivated by these evidences, I develop an equilibrium model to price simultaneously assets and repos.
I show that assortative matching between assets and lenders offering different maturities exists in equilibrium. Lenders who offer longer maturities are better suited to finance less liquidity securities, since investors' expected transaction costs are lower, as collateral (to repay debt) is sold long after their debt is considered unworthy. Liquid securities prices increase with repos, in order to make the financing of illiquid securities more attractive to long maturity lenders. Interest rates and haircuts are functions of both the transaction costs and maturities distributions, and are shown to be increasing in illiquidity. Haircuts exceed the securities' transaction costs, in order to cover how much securities depreciate when sold, and to force borrowers to repay the interest on their debt. Moreover, illiquid securities have higher haircuts, because not only they have larger transaction costs but also because the repos used to finance them pay more interest. I emulate a financial crisis through an increase in the probability of a debt run. As repos are terminated earlier, all asset prices decrease. Illiquid securities prices, however, fall notably more and haircuts and interest rates of repos to fund them increase.
In chapter 3, which is co-authored with Siwei Kwok, we study the interaction of information and competition in incentivizing quality provision. We estimate a discrete quality game with Los Angeles County restaurant hygiene inspection data set, via the two step method of Bajari et al (2006). Our results suggest that firm competition incentivizes quality provision, but the effect is non-monotonic. If a market is saturated with a sufficiently large number of firms, an additional firm might actually reduces the likelihood that all others will provide quality. Information, however, enhances the effects of competition and reduces the threshold which additional firms reduce quality provided.