Three essays in financial economics

Abstract

This PhD dissertation is made up of three stand-alone research projects. One on financial accounting and macroeconomics while the two others are empirical asset pricing projects, in the equity and currency markets. In the first project, I examine whether aggregate cost stickiness predicts future macro-level unemployment rate. I find that a one-standard-deviation-higher cost stickiness in recent quarters is followed by a 0.23 to 0.26-percentage-point-lower unemployment rate in the current and following quarter. In out-of-sample tests, I find significant reductions in the root-mean-squared-errors upon incorporation of cost stickiness for all models. These findings suggest that professional macro forecasters do not fully incorporate the information contained in cost stickiness.

In the second project, I investigate the impact of crude oil balance of trade on the cross-section of currency returns for 36 countries. Using classical asset pricing methodology, I find that a long/short quintile portfolio of currency sorted on oil balance of trade is priced and induces an annual risk premium ranging from 2.4 to 2.9%. I conduct the analysis using individual currencies and portfolios as test assets, both leading to the same conclusion. I also find that characteristics subsume factor beta and, hence, confirm results in the equity market (Chordia, Goyal and Shanken 2015). More interestingly, I show that the net oil balance of trade characteristic, specific to each country and varying over time, contains incremental information relative to the carry characteristic that explains currency excess returns. The fact that not only oil price but also oil net balance of trade plays a role in asset pricing is completely new to the literature.

In the third project, I explore the effect of time-varying arbitrage capital availability on the cross-section of abnormal equity returns. I investigate the relationship between arbitrage capital, proxied by a market wide-liquidity measure introduced by Hu, Pan and Wang (2013), and the future performance of a set of eleven well-known pricing anomalies. When arbitrage capital is abundant, investors are able to deploy arbitrage strategies more successfully, which leads to lower future profitability of pricing anomalies. In contrast, when arbitrage capital is scarce, investors are unable to deploy enough capital to take advantage of pricing anomalies, yielding higher profitability of the anomaly strategies subsequently. Consequently, as a priced factor, time-varying arbitrage capital helps to explain the cross-sectional returns of pricing anomalies.