Three essays in Asset Pricing under Model Uncertainty
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University of North Carolina at Charlotte
This dissertation consists of three essays on asset pricing under model uncertainty. The first essay examines how aversion to uncertainty about the information transfer across firms affects asset prices in an equilibrium. I show that a firm's stock price reacts more strongly to the bad news than the good news from its economically linked firms, and there is price inertia if the news is not strong enough. Moreover, I show that equilibrium prices do not always fully incorporate relevant firm-specific news. The stock price movement displays overreaction and underreaction, depending on the magnitude of the news, the information quality, the strength of the economic link, the firm size, and the firm risk. The model further explains the asymmetric pattern of financial time series, including the expected stock return and volatility, and the correlation and covariance. The model offers several testable predictions, which are consistent with recent empirical studies on how asset prices and returns are affected by the firm-specific news. In the second essay, I construct an equilibrium model in the presence of correlation uncertainty and heterogeneous ambiguity-averse investors, in which correlation uncertainty and asset characteristics jointly affect asset prices and trading activities. The price of low-weighted volatility assets declines, the retail investor holds a smaller position when the correlation uncertainty goes up; meanwhile, the price of high-weighted volatility assets increases, and the retail investor holds a larger position. The institutional investor provides liquidity and holds a well-diversified portfolio. Moreover, all risky assets comove more under higher correlation uncertainty. This model explains several empirical puzzles including under-diversification and limited participation, flight-to-quality, and asset comovement.In the third essay, I present a dynamic equilibrium model of financial innovation when the investor is more prone to time inconsistency than the innovator. I analyze the effects of heterogeneous beliefs among agents on the security's viability and equilibrium pricing. I demonstrate that the market of forward-type securities is more resilient to the underlying market movement compared to the market of option-type contracts, where securities are vulnerable to the underlying market condition and may disappear with a drastic market movement. The model is extended to examine some complex financial instruments with multiple tranches, such as collateralized debt obligations (CDOs) and the pattern of financial innovation under model uncertainty. The analysis explains the recent boom and bust of securitization market and the high-yield puzzle of senior tranche of CDOs during its heyday.
ASSET PRICINGCORRELATION AMBIGUITYHETEROGENEOUS BELIEFSMODEL UNCERTAINTYPORTFOLIO CHOICE
Kirby, ChristopherHan, YufengZhou, Jing
Thesis (Ph.D.)--University of North Carolina at Charlotte, 2018.
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