▼ As exchanges have provided more transparency for their products, there has been increased interest in determining how order flow and the state of the order book impact order submissions and price discovery. Studies of order books have noted the presence of orders that are fleeting and might be classified as spoofing orders. Spoofing is a microstructure based trading strategy which has recently been classified as prohibited under the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) (“Dodd-Frank Act”). Section 4c(a)(5) of the Commodity Exchange Act in section 747 of the Dodd-Frank Act specifically prohibits trading that “is, is of the character of, or commonly known as ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).” For example, a trader who places a spoofing order on the buy side will create the illusion of excess demand over supply by placing a large limit order on the bid side. The intent of the spoof order is for the trader to actually sell contracts at a higher price than is currently available. If successful, other traders will perceive that there is real information in this large limit order and trade ahead of it, thereby raising the price. This allows the spoofer to cancel the limit order and place a market sell order at a price that is at least one tick higher than the price at the time the spoofing order was submitted. To date, there are only two other studies that specifically study spoofing orders. This dissertation is the only study of spoofing orders that examines spoofing orders from an order book perspective rather than examining individual traders’ order submission, cancellations, and trades. This dissertation utilizes limit order book data for European equity index futures to test for possible spoofing orders. Findings indicate that approximately 15% of large imbalances in DAX futures contracts result in a price change that could be indicative of a successful spoof order. On the other hand, only about 5% of large imbalances in DJ Euro STOXX 50 futures contracts end with a change in price that could indicate a successful spoofing order. Advisors/Committee Members: Holder, Mark.

▼ Executive compensation plans have become a topic of interest in the popular press recently due to the amount of compensation that top executives are earning. A strand of executive compensation studies has developed concerning how a firm’s risk exposure affects its compensation decisions. Recent work by Jin (2002) and others extend this school of thought by decomposing total risk into market risk and firm specific risk. These studies examine the impact of these risk components on optimal compensation designs. While these prior studies focus on the levels of these risk components, it is questionable whether the weights of these risk components make a difference in executive compensation. If when both risk components increase or decrease, their proportions in the total risk may vary differently. This dissertation computes the goodness of fit (R-squared) of the traditional firm specific market model to measure the percentage of a firm’s stock returns driven by market factors. This R-squared is used as a proxy for the proportion of a firm’s market risk in its total risk. Next, this factor is applied to research questions on the relation between risk structure and executive options, that is, stock options paid to chief executives.The results of the dissertation indicate that during the time period of 1992 to 2001, executive options are preferable compensation to firms that are exposed to a high market risk. In 2002 and 2003, risk structure becomes a statistically insignificant factor on executive options. When it comes to 2004, the practical use of executive options becomes popular in low market risk firms instead of high market risk firms. Furthermore, the results show that the risk structure is especially an important factor for executive options in old economy firms and in firms whose CEOs hold small amounts of their firm’s stocks. Advisors/Committee Members: Holder, Mark E.

▼ Financial markets demonstrate a large degree of comovement. Such comovement is important for a variety of investment and risk management decisions. This research is motivated by 2007-2008 financial turmoil. During the turmoil period, the markets co-move locally and globally, making it difficult for investors to hedge the risk. Although the cross market linkage is a topic of ongoing interest to researchers and practitioners, it seems that we are still in the preliminary stage to fully understand the cross market linkages, and even far away to prevent the crisis transmitting across markets. This dissertation attempts to answer two main questions, what are the major channels that link financial markets, and how those channels change in different periods. In this study, we examine two empirical tests on domestic markets and international markets linkage respectively. The first test focuses on the financial markets within U.S, and treats the stock, bond, CDS, stock option markets as a closely connected network. From 2004-2009, our tests find no evidence that static cross-market linkage becomes stronger in the crisis period than in the normal period. In terms of dynamic linkage, we find the information flow pattern become stronger in the crisis period. And we identify the role of volatility and liquidity in the financial network. The second test focuses on the international markets linkage using the derivatives market information. We use a family of volatility indexes from 1999-2009, including VIX, VSTOXX, VDAXNEW, VXJ, and VSMI, to filter the information diffusion through other channels. Therefore, the tests contribute a unique perspective to find out how the investors expect the interaction of the near-term volatility across U.S. and international markets. Our tests provide evidence that the linkages across corresponding markets are stable in the past decade. And we also find U.S. market plays a stronger role in a two way information flow structure with other markets through volatility linkage. The dissertation contributes a comprehensive research on the financial network linkage. The results obtained in this dissertation will improve our understanding of information diffusion process across financial markets and are expected to fill significant gaps in the current literature. Advisors/Committee Members: Dawson, Paul.

▼ Nations have broadly varying cultures of equity financing. This dissertation examines both cross-national differences in the price of equity risk and cross-national differences in preference for equity financing, with a view toward how social factors such as trust, in the sense of actual and perceived contract reliability, affects nations’ cultures of equity. As a planning measure for long-term investments, the equity premium is an important estimate. Nevertheless, there is little agreement on the empirical estimates of the equity premium in various countries or on the methods most appropriate for estimating the equity premium. Using improved and consistent methodologies, for the first time this dissertation provides equity premium estimates using two different estimation procedures for wide sample of countries covering a recent eight-year period. While Residual Income Growth (RIV) and Abnormal Earnings Growth (AEG) estimates follow similar trends though time, it is found that AEG estimates are consistently lower and less variable. Next, unlike prior studies, this dissertation assesses national characteristics as determinants of cross-border differences in equity premia. It is found that country equity premia narrow with greater concentration of equity ownership and greater economic inequality. Country equity premia widen with more uncertainty avoidance as well as more stock and bond market development, and better legal protection and regulatory quality. Results point to non-pecuniary benefits to holding equity or to controlling ownerships having preferential access to capital. Further, there is little research on the degree to which nations’ reliance on markets versus institutions is determined by cultural, legal, and other national characteristics. This dissertation documents that national preference for market financing is associated with increased private monitoring of banks, market openness, and market concentration. Less national preference for market financing is associated with measures reflecting greater anti-self dealing laws, more ambiguity aversion and greater official supervision of banking. Overall, this dissertation makes important new contributions to a better understanding of the nature and role of equity financing in wide range of countries. Given the importance of returns on long range corporate equity investments and corporate equity as a source of investments, these contributions should be of much interest to scholars, managers, and policymakers. Advisors/Committee Members: Aggarwal, Raj.

▼ Prior research advances a “life-cycle” or maturity hypothesis to explain the corporate dividend policy for industrial firms. Empirical studies show that young firms with ample investment opportunities do not pay dividends while mature firms with limited investment opportunities pay dividends. However, prior investigations of the life-cycle hypothesis utilize different measures of maturity that capture different dimensions of a firm’s life-cycle. The prior studies show that firm age, the earned capital ratio, and risk are statistically significant measures of maturity when tested independently. This dissertation investigates all these measures of firm maturity jointly in order to determine which maturity variable or combination of maturity variables best explains a firm’s dividend policy. The investigation indicates that firm maturity is a complex concept. Age, earned capital ratio, and standard deviation (total risk) all contribute to the definition of maturity, and the relationship between dividend policy and the life-cycle is better quantified by combinations of these variables. Firms with dividend policies that follow the life-cycle model have higher valuations than firms with contrary dividend policies. Empirical evidence supports that the life-cycle model is consistent with maximizing firm value. The dissertation provides an answer to Black’s (1976) dividend puzzle. Firms pay a dividend to maximize their valuation, depending on their maturity. By combining valuation with the life-cycle, I can empirically indicate when a firm should pay a dividend in the life-cycle. Furthermore, the investigation offers an explanation to Fama and French’s (2001) “disappearing dividends” phenomena. “Disappearing dividends” occurs due to the decline in propensity to pay by marginal dividend payers. The decline in these “over-zealous” dividend payers is due to the decline in the valuation premium. Consistent with the maturity hypothesis, the dividend payout ratio increases with firm maturity; however, the dividend growth rate declines with firm maturity. A life-cycle model for the dividend growth rate is better than the sustainable growth estimate. Advisors/Committee Members: Thornton, John.

▼ Asset pricing modelers attempt to identify price diffusion processes from empirical financial market data. In particular, the Geometric Brownian Motion and the GARCH models are currently popular in these efforts. In contrast, for the first time this dissertation identifies Multifractal Models of Asset Return (MMARs) from the eight nodal term structure series of US Treasury rates as well as Fed Funds rate and, after proper synthesis, simulates those MMARs. The model performance results of these simulations are then compared with not only the original empirical time series, but also with the simulated results from the corresponding Brownian Motion and GARCH processes. The major findings are that the eight different maturity US Treasury and the Fed Funds rates are multifractal processes. The MMAR outperforms both the GBM and GARCH(1,1) in terms of scaling distribution preservation over time and investment horizons. In addition, this dissertation uses the noise-data ratio to improve the Holder-Hurst identification for the power spectrum method. Identified distributions of all simulated processes are compared with the empirical distributions in snapshot and over time-scale (frequency) analyses. The findings suggest that the simulated MMAR can replicate all attributes of the empirical distributions, while the simulated GBM and GARCH(1,1) processes cannot preserve the thick-tails, high peaks, and skewness. The wavelet scalograms, used to investigate the variance over time and scales, reveal the superiority of the MMAR for modeling the Treasury rates over the GBM and GARCH(1,1). When the MMAR is applied to the Fed Funds rate, the results are surprisingly different from those of the Treasury rates. The MMAR at this stage cannot produce a complete term structure model, because it cannot completely model the dynamic structure of the term structure. Advisors/Committee Members: Los, Cornelis A.

▼ We develop a new social trust index from the World Value Survey. Applying the newly developed social trust index across countries, we investigate the relationship between social trust and various financial development proxies. We find that the social trust index can be improved when we use the composite approach. We find that social trust can explain variations of private credit, private bond, and stock market valuation as a percentage of GDP. We also apply the newly developed social trust index in investigating the ownership concentration and ultimate state ownership. Higher social trust reduces ownership concentration. We also apply the theory proposed by Stulz (2005) and find that state ownership is more dominant where social trust is low. The evidence suggests that social trust is a determining factor of controlling state ownership. Using the trust factor developed in the first essay, we investigate how the trust level of each country affects disclosure of information. Furthermore, we test how social trust plays a role in determining the level of moral hazard of banks. We find that social trust is a positive and significant factor in determining banks’ disclosure across countries. We also find that social trust has a negative impact on moral hazard index across countries, implying that social trust reduces cross national banks’ moral hazard activities. Results are robust. Advisors/Committee Members: Aggarwal, Raj.

▼ Many statistical early-warning models have proven to have some predictive power. These models involve five basic approaches: logit, discriminant analysis, proportional hazard models, trait, and robust regression. If markets are at least semi-strong form efficient, then prices must already incorporate any information that could be obtained by using these statistical early warning systems. In this case, either early warning systems do not have special predictive power, or the information they provide is quickly obtained by markets, probably through industry analysts who utilize such models in their analysis. If these systems can be used to earn abnormal profits, then the efficiency of equity markets is called into question. In this dissertation, I utilize these five early warning systems to find problematic banks using data from 1986 through 2009. A zero cost arbitrage portfolio is formed each quarter by shorting the banks identified by the models as potential problems and going long the remaining non-problematic banks in the sample. The risk adjusted returns on the arbitrage portfolio and its long and short components is compared to risk adjusted returns on a long portfolio of all banks in the sample. If the returns on any of these portfolios are statistically greater than the “all bank” we can infer that the early warning system is able to provide information not available to investors and can conclude that the market is not semi-strong form efficient. I find that using market returns for portfolios formed by bank EWS is a viable universal standard to judge their ability to discern problematic banks and conclude that newer and/or more complex EWS do not perform better than older and/or simpler models over long periods of time. Only two of the models are able to beat the naïve all bank portfolio on a risk adjusted basis over the entire term and none are able to beat the market on a risk adjusted basis, but all are able to form a long portfolio able to screen out some underperforming stocks and so beat a naïve strategy on an unadjusted for risk basis. From this, I conclude that the market for publicly traded commercial banks is highly, but not perfectly, semi-strong form efficient. Advisors/Committee Members: Thornton, John.

▼ This dissertation empirically evaluates the relations among macroeconomic variables, systematic risk factors, and market valuation ratios. Market valuation ratios are utilized as proxies for investors’ expected or required returns. As such they are impacted both by changes in expected economic activity and by changes in perceived risk levels. To better understand the relations between market valuation ratios, economic changes, and risk factors, this dissertation undertakes three related analyses.The first essay, “In Search of a Better Market Earnings Yield (E/P) and a Better Market Dividend Yield (D/P),” evaluates the relations between market valuation ratios and the components of interest rates, with controls for various factors. This essay demonstrates that interest rates are related to valuation ratios and that adjusting for this identified relation improves the utility of valuation ratios in forecasting market returns. The second essay, “Systematic Risk Factors and Cash Flow Factors and Their Relations to Market Valuation Ratios as Proxies for Investors’ Required or Expected Returns,” evaluates the effects of state variables on market valuation ratios, specifically the E/P ratio and the D/P ratio. This essay identifies which macroeconomic or state variables represent or capture systematic risk factors and which macroeconomic variables affect investors’ expected returns, as measured by market valuation ratios. The third essay, “SMB and HML: Risk Factors?”, evaluates if SMB (Small Minus Big return differentials based on the total size of market equity) and HML (High Minus Low return differentials based on book-to-market ratios) do worse relative to other equity investments in “bad” times and thus warrant a return premium as compensation for this “risk” factor. Based on this evaluation, this essay corroborates that SMB is a risk factor but provides evidence that HML is actually a contra-risk factor. In summary, this dissertation studies the relations among risk factors, macroeconomic variables, and market valuation ratios so as to enhance the understanding of how risk factors and macroeconomic variables impact equity market valuations and equity market returns. Advisors/Committee Members: Thornton, John.

▼ Risks in the banking industry occasionally come into the public spotlight due to events such as the recent financial crisis. This study examines risk characteristics of bank holding companies (BHCs) based upon their use of interest rate derivatives. Prior research examining interest rate derivatives in BHCs is based upon data prior to the required segregation indicating whether or not derivatives are used for trading. This research uses segregated derivative data. BHCs are divided into those using no derivatives, those using non-trading derivatives, and those using both trading and non-trading derivatives. Differences in both interest rate sensitivity and overall firm risk between BHCs of differing derivative types are analyzed. Evidence indicates BHCs using non-trading derivatives have higher interest rate sensitivity than those using no derivatives. In addition, BHCs using both non-trading and trading derivatives have greater interest sensitivity than BHCs using only non-trading derivatives. BHCs using derivatives regardless of type do not exhibit greater overall volatility than BHCs using no derivatives. Selective hedging, partially but not fully hedging a risk exposure, is also examined. BHCs successfully trading in derivatives must invest in personnel with the requisite expertise. It is plausible these BHCs would leverage this expertise to selectively hedge in their non-trading portfolio. Whether or not these BHCs selectively hedge is inconclusive. However, in most instances, derivative positions in the non-trading portfolio of these BHCs are advantageous. Whether operational hedging is a substitute for or a complement to financial hedging is also explored. Prior research limits operational hedging in BHCs to merger and acquisition activity. This research examines operational activities involving geographic diversification, loan diversification, and non-interest income diversification. Evidence supports these operational activities act as hedges and are substitutes for financial hedging. Of the three operational hedges examined, only geographic diversification is associated with decreased BHC interest rate sensitivity. This dissertation contributes to existing literature by fostering a clearer understanding of BHC risk management strategies. Given the crucial role the health of the banking industry plays in the overall health of the economy, understanding how banks manage various risks is beneficial to regulators and investors. Advisors/Committee Members: Thornton, John.

▼ Most recent empirical literature focuses on the information content of option volume for future security price movements. Few of these studies explore the possibility that there is information content in the option order book about the underlying security’s future price movements. This dissertation explores this possibility. We first find that the book imbalance defined as scaled difference between asked size and bid size at the best limit price levels in the Euro-Bund futures option order book is significantly related to short-term its futures returns only for at-the-money (ATM) options. However, book imbalances beyond the best price levels are not informative to the Euro-Bund futures price movements. We further document that, when trading cost, measured by the bid-ask spread, is relatively high (more than 3 ticks), there is no price discovery from the Euro-Bund futures ATM option market to the Euro-Bund futures market. However, when the trading cost is relatively low (less than 2 ticks), information in the Euro-Bund futures ATM option market is associated with its futures returns. Finally, we show that Euro-Bund futures ATM put options are more informative than its ATM call for the underlying futures price formation in periods with more negative news surprises regarding interest rate risks. The dominance of Euro-Bund futures ATM put options is mainly due to market environments. This is consistent with the notion that traders seek protection against downside of interest rate risk by buying puts rather than selling calls in periods with more negative news surprises regarding interest rate risks. Advisors/Committee Members: Holder, Mark.

▼ Agency cost is a major factor that constrains corporate finance decision making. Current corporate governance theory focuses primarily on agency costs of managers and existing literature studies extensively on this aspect. This dissertation studies agency costs from a unique point of view: it addresses the agency costs of creditors and employees. It tests the relationship between creditor rights as well as employee rights and corporations’ financing and dividend payment decisions across countries. Based on a sample of 182, 182 firm-year observations from 21,663 unique firms over 52 countries, this study uses the year- and industry-fixed effects Tobit model to test the impacts of creditor rights and labor rights on debt ratio in different countries. The empirical results reveal a positive relationship between employee rights and firms’ use of debt and a negative relationship between creditor rights and firm debt ratio. Such relationships hold valid when tests are implemented by using pooled country sample, country mean of residuals, and different country-group sub-samples. The results imply that in countries where employee rights are high, shareholders will use more debt obligation to reduce possibility of exploitation by employees whereas in countries where creditor rights are high, it is harder for shareholders to get a favorable debt contract and they will reduce the use of debt capital. Running fixed effects Logit and Tobit models, this study also documents that labor rights are negatively related to firms’ decision to pay dividends and dividend payment amounts. This relationship is reinforced to be more salient in civil law countries where shareholder rights are weak. The empirical results are robust by controlling for sample selection bias, test model specification, and a series of country-level control variables. The explaining power of the major creditor rights and labor rights variables keeps significant statistically, implying that the empirical results remain valid after taking country-specific economic characteristics into account across countries. This is the first study that examines agency costs of employees in corporate finance context explicitly. It takes all stakeholders into account when studying agency problems and sheds light on the interaction relationship among shareholders, creditors, and employees across countries. The empirical results of this study provide a new perspective to interpret international variations in financial leverage and dividend policy in the world. Advisors/Committee Members: Zhao, Shelly.

▼ Empirical studies often show that diversified firms trade at a discount compared to stand-alone firms. The commonly accepted explanation in early studies is that diversification reduces value because of inefficiency in asset allocation and management capability. However, such arguments neglect the real options value incorporated in the value measures employed in diversification studies. It does not explain why a firm diversifies if diversification is ex ante inefficient either. Our study indicates that diversification activities are strategic decisions that will change the growth opportunities, and thus the real options, of a firm and will create value impacts that are different from those caused by changes in operational efficiency. In our study, the theoretical framework of diversification effects is improved by formalizing two contrasting arguments into their corresponding theoretical paradigms. First, under the resource-based view of firm and transaction cost economy argument, unrelated diversification will generate more transaction costs when compared to related diversification, therefore it will be less beneficial to firm value than related diversification. Second, under the real options framework, unrelated diversification tends to have a positive impact on firm value because it creates new growth opportunities for a firm; while related diversification tends to reduce the value measure of a firm because it exercises growth opportunities and thus reduces the real options value. We categorize firms into below industry median and above industry median groups based on their pre-diversification performance. Comparison tests on value changes around diversification and regression analysis indicate that diversification activities have different value implications to below and above median firms. Diversification activities, especially unrelated diversification activities, carried out by below industry median firms tend to be efforts to search for new growth opportunities and firm values tend to increase after diversification. Whereas diversification activities carried out by above industry median firms tend to be moves to exploit excess capabilities and the firm values tend to decrease after diversification. Lower than average performance of a firm tends to suppress the usefulness of some resources, such as research and development input. Diversification may create new opportunities for such resources, so higher research and development level may lead to more future benefits for previous below industry median firms. On the other hand, the future benefits that can be generated by the unique resources possessed by above industry median firms have been fully reflected in current market value. A real assets investment through diversification that materializes these potential will bring down the market-to-book ratio. We find that value changes around diversification are more related to the changes of future growth opportunities rather than the changes of operational efficiencies. It is inappropriate to talk about an overall value impact of all types of diversification activities. The results do not refute the cross-sectional evidence that diversified firms tend to have a lower value compared to focused firms. But such evidence is a collective outcome of the value increase of below average performers and the value decrease of above average performers. It is not an evidence of value destroying effect of diversification. Our study fills the gaps in the diversification literature in which there is disagreement on whether the documented diversification discount is evidence of value destruction. The evidence is also useful for practical diversification decision-making processes. Advisors/Committee Members: Holder, Mark.

▼ My dissertation is a study of corporate investment behavior under market imperfections. This dissertation is structured as three inter-related essays that each addresses a particular aspect of the investment behavior of firms and all share common themes which are 1) market imperfections complicate managerial decisions on investments; and 2) the models based on perfect market assumptions may not be correct. The first essay, The Relationship between Internal Cash Flow and Investments, studies the puzzle of the sensitivity of corporate investments to internal cash flows and finds that a U-shaped sensitivity curve between investment and cash flows can be clearly identified in the US and in most other countries studied. The second essay, The Relationship between Market Valuation and Corporate Investments, studies the relationship between stock market valuation and firm investments using a model controlling for many market imperfection components and employing simultaneous equations estimates. Essay two finds that both market perceptions and fundamental factors are important influences on corporate investment decisions. Moreover, we document that market valuation has a much higher impact on investment than fundamental variables, which seems to be consistent with the contentions in Barro (1990) and Baker et al. (2003). The third essay, Who Will Benefit from Diversification: A Transaction Cost View of Diversified Firms, studies the issue of diversification and using data for a number of countries finds that both firm-level and country-level variables are important determinants of the excess values of diversified firms. We find that country risk, legal system, country disclosure level, information asymmetry measures, and agency cost measures are all important factors that influence diversified firm values. Our findings are largely consistent with those suggested by the transaction cost theory and provide a new perspective for the evaluations of firm diversification. In summary, this dissertation studies the impacts of market imperfections on corporate investment decisions and suggests that when operating in an imperfect market, a firm’s investment decision-making process is influenced by cash flows, stock prices, and transactions costs, and is much more complicated than in perfect markets. Advisors/Committee Members: Aggarwal, Raj.