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Essays on asset pricing

Zhang, Cheng (2016) Essays on asset pricing. PhD thesis, London School of Economics and Political Science.

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This thesis contains three essays on asset pricing. The first chapter examines how introducing an options market affects the liquidity and expected returns of underlying assets when the economy features asymmetric information. I show that introducing derivatives can have opposite effects on underlying asset prices: doing so increases (resp., reduces) prices when the market has relatively more liquidity suppliers (resp., liquidity demanders). Thus the non-monotonic effects of derivatives on underlying assets could reconcile the mixed empirical evidence on options listing effects. Introducing derivatives reduces the price impact of liquidity demanders’ trades on the underlying risky asset but has no effect on its price reversal dynamics. In the second chapter, I solve for the equilibrium of a pure-exchange Lucas economy under jump diffusion and populated by one unconstrained agent and one VaR agent in closed form. First, I show that the VaR constraint can generate excess market volatility and the inclusion of the jump component amplifies this effect, which provides a new mechanism to explain the prevalent smirk pattern of Black-Scholes implied volatility in options markets. Second, the VaR constraint pushes up the jump risk premium. Finally, the VaR constraint can generate a decline in the zero coupon bond yields at the VaR horizon, which is consistent with a flight to safety phenomenon taking place during a crisis. The third chapter, co-authored with Chunbo Liu and Zhiping Zhou, documents a positive relationship between funding liquidity and market liquidity in the options market. Further analysis reveals that the positive relationship is mainly driven by short-term and deep out-of-the-money options. Furthermore, liquidity of puts is more sensitive to changes in funding liquidity. In addition, this paper finds a positive relationship between the options market liquidity and VIX, which is in contrast to the negative relationship documented in the equity market.

Item Type: Thesis (PhD)
Additional Information: © 2016 Cheng Zhang
Library of Congress subject classification: H Social Sciences > HG Finance
Sets: Departments > Finance
Supervisor: Julliard, Christian and Tamoni, Andrea

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