UC San Diego

Chapter 1 introduces a model-free methodology to assess the impact of disaster risk on the market return. Using S&P500 returns and the risk-neutral quantile function derived from option prices, I employ quantile regression to estimate local differences between the conditional physical and risk-neutral distributions. The results indicate substantial disparities primarily in the left-tail, reflecting the influence of disaster risk on the equity premium. These differences vary over timeand persist beyond crisis periods. On average, the bottom 5% of ex-ante returns contribute to 17% of the equity premium, shedding light on the Peso problem. I also find that disaster risk increases the stochastic discount factor’s volatility. Using a lower bound observed from option prices on the left-tail difference between the physical and risk-neutral quantile functions, I obtain similar results, reinforcing the robustness of my findings.

Chapter 2 explores the relation between the size of a defined benefit pension plan and its choice of active vs. passive management, internal vs. external management, and public vs. private markets. We find positive scale economies in pension plan investments; large plans have stronger bargaining power over their external managers in negotiating fees as well as having access to higher (pre-fee)-performing funds, relative to small plans. Using matching estimators, we find that internal management is associated with significantly lower costs than external management, reinforcing the enhanced bargaining power of large pension plans that have fixed-cost advantages in setting up internal management.

In chapter 3, we analyze how financial institutions can hedge their balance sheets against interest rate risk when they have long-term assets and liabilities. Using the perspective of functional and numerical analysis, we propose a model-free bond portfolio selection method that generalizes classical immunization and accommodates arbitrary liability structure, portfolio constraints, and perturbations in interest rates. We prove the generic existence of an immunizing portfolio that maximizes the worst-case equity with a tight error estimate and provide a solution algorithm. Numerical evaluations using empirical and simulated yield curves from a no-arbitrage term structure model support the feasibility and accuracy of our approach relative to existing methods.