Essays in Financial Economics

Abstract

This dissertation consists of three independent essays on the understanding of investor behavior and financial markets. Chapter 1 (co-authored with Zhong Xu and Chuanwei Zou), “Trading Relationships in the Chinese Repo Market,” studies relationship formation in the Chinese repo market and its impact on the terms of trade. We find that relationships play an important role. In particular, banks with stronger pre-existing ties are more likely to trade with each other again. They also trade at lower rates, require smaller haircuts and have looser standards on collateral. Our results suggest that relationships reduce both search frictions and counter-party credit risk in the Chinese repo market. Chapter 2, “Retail Investors’ Ownership Breadth and Stock Returns,” analyzes the ownership breadth of different groups of retail investors and their predictive powers for future returns. We document that there exists heterogeneity among retail investors in the changes of their ownership breadth. While the change in ownership breadth of large retail investors and institutional investors predicts positive returns, the change in ownership breadth of small and medium investors predicts returns negatively. The results are consistent with a model in which rational traders have an information advantage over noise traders. Chapter 3, “Price-based Momentum and Earnings-based Momentum,” compares momentum strategies based on firms’ stock prices with momentum strategies based on their earnings surprises in order to test whether firms’ past performance contains any additional information on predicting future returns controlling for past earnings surprises. In contrast to earlier studies, we find that both firms’ past idiosyncratic returns and earnings surprises can predict future returns and earnings surprises after controlling for each other. Our findings indicate that price-based momentum and earnings-based momentum are two distinct phenomena that represent the market’s under-reaction to different pieces of information.