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Essays on information and frictions in financial markets

Han, Yueyang (2019) Essays on information and frictions in financial markets. PhD thesis, London School of Economics and Political Science.

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The first chapter studies the dynamics of information acquisition and uncertainty in a noisy rational expectations model. Investors choose to acquire most information at times when uncertainty and risk premia are high; this choice feeds back and endogenously reduces subsequent uncertainty. Within the model, uncertainty can be measured directly from risk-neutral variance—analogous to the VIX index—so this translates into the concrete prediction that risk-neutral variance mean-reverts rapidly following spikes in volatility, as is observed empirically. The cyclicality of information acquisition depends on the skewness of the underlying asset: if the market is negatively skewed, market-level information acquisition is countercyclical. Conversely, information acquisition and risk premia are high following good news for positively skewed assets such as individual stocks, which gives rise to momentum in the stock market. In the second chapter, my co-author and I consider an economy populated by investors with heterogeneous preferences and beliefs who receive non-pledgeable labor incomes. We study the effects of collateral constraints that require investors to maintain sufficient pledgeable capital to cover their liabilities. We show that these constraints inflate stock prices, give rise to clusters of stock return volatilities, and produce spikes and crashes in price-dividend ratios and volatilities. Furthermore, the mere possibility of a crisis significantly decreases interest rates and increases Sharpe ratios. The stock price has a large collateral premium over non-pledgeable incomes. Asset prices are in closed form, and investors survive in the long run. The third chapter studies information acquisition with a long-lived risky asset that generates dividends in each period. The investors can either be informed or uninformed, and the informed investors actively acquire information on the timevarying dividend growth rate. Informed investors take short positions in the variance swap to realize their informational advantage; the uninformed investor takes a long position to hedge his risks. Serial correlation of returns is decreasing in information acquisition of informed investors. Low uncertainty induces investors to acquire less information and decreases the cross-sectional dispersion of beliefs in expected returns.

Item Type: Thesis (PhD)
Additional Information: © 2019 Yueyang Han
Library of Congress subject classification: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
Sets: Departments > Finance
Supervisor: Martin, Ian

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