Essays in Financial Economics

Abstract

The first chapter studies how dealers affect the liquidity of the corporate bonds market. Using corporate bond transaction data with dealer identifiers, I find that a large component of the bid-ask spread is dealer-dependent. Customers incur different trading costs depending on which dealer handles their transactions. The dealer-specific component of trading costs is related to several characteristics of dealers, including their connectedness, credit risk, and portfolio risk. These findings are consistent with an inventory risk model of the bid-ask spread, whereby shocks to a dealer’s inventory cost affects the equilibrium bid-ask spread. The second chapter, joint with Ali Ozdagli, studies how interest rates influence the investment behavior of insurance companies. Life insurance companies, the largest institutional holders of corporate bonds, tilt their portfolios towards higher-yield bonds when interest rates decline. This tilt seems to be primarily driven by an increase in duration rather than credit risk and insurers do not seem to increase the credit risk of their bonds as interest rates decline. Moreover, the duration gap between their assets and liabilities deviates from zero for extended periods of time both in negative and positive directions. We propose a new model of duration-matching under adjustment costs that conforms with these patterns and test other implications of this model. The third chapter, joint with Luis Viceira, documents that the short-run correlations of returns across countries have increased substantially from 1986 to 2016, both for equities and bonds. We identify increased correlations of discount rate shocks, a transitory component of returns, as the main driver of the upward shift in stock return correlations. We conclude that the increase in short-run correlations does not imply decreased long-horizon benefit for diversification in global equities market. In addition, we investigate the optimal intertemporal global portfolio choice problem for long horizon investors in the presence of permanent shocks and transitory shocks to asset values.