This dissertation consists of three chapters describing the applications of factor models in different fields of asset pricing. The first chapter addresses the following issue: Prominent volatility-based factor pricing models focus exclusively on the second moment of asset returns, and hence, tend to identify volatile factors but with little risk premia. This chapter demonstrates that a simple asset return transform can arbitrarily upset the ranking of volatility-based factors, but not their prices of risks. Accordingly, we propose a new framework to identify factors based on their prices of risks, or the so-called principally priced risk factors (PPRFs). We construct these factors by generalizing the standard Sharpe ratio for a single asset to a set of assets, incorporating information from both the first and second moments of asset returns. The PPRF framework improves out-of-sample pricing performance in both equity and currency markets.
The second chapter identifies the origins of covariance in institutional trading. Conceptually, we introduce two perspectives: the asset perspective, which prioritizes assets as the key market fundamentals, and the manager perspective, which prioritizes fund managers as the key market fundamentals that drive institutional trading covariance. Empirically, we establish that the asset perspective is the primary driver of covariance in institutional trading. Our analysis documents two further empirical patterns. First, returns stemming from the covariance in institutional trading from the asset perspective have higher volatility, offering valuable insights into the demand-based asset pricing literature. Second, the persistence in trading often breaks down during economic downturns, suggesting potential connections to the uncertainty-based business cycle literature.
Finally, the third chapter examines the impact of changes in monetary policy rules on the asset valuations of firms with different profitability. I have the following two empirical findings. First, during periods of hawkish monetary policies, the 'profitability premium'— the expected extra return on investments in more profitable firms — tends to increase. Second, when analyzing the factors mediating this effect, changes in inflation expectations play a more significant role in influencing the profitability premium during transitions to a hawkish monetary regime, compared to the effects of real interest rate adjustments on production costs. These observations suggest a possible mechanism by which monetary policy may have different long-term effects on firms with different characteristics. / Doctor of Philosophy / This dissertation explores factor models in asset pricing across three chapters. The first chapter critiques volatility-based models that focus on asset return variance and introduces a new framework for identifying factors based on risk prices, enhancing pricing performance in equity and currency markets. The second chapter investigates the origins of covariance in institutional trading, emphasizing the asset perspective as the dominant influence and documenting higher volatility and breakdowns in trading persistence during economic downturns. The third chapter examines the effects of monetary policy changes on firm asset valuations, finding that hawkish policies increase the profitability premium, significantly influenced by shifts in inflation expectations rather than changes in real interest rates. These insights highlight the nuanced impacts of market fundamentals and monetary policy on asset pricing and firm profitability.
| Identifer | oai:union.ndltd.org:VTETD/oai:vtechworks.lib.vt.edu:10919/119009 |
| Date | 16 May 2024 |
| Creators | Lin, Chun-Wei |
| Contributors | Finance, Edelen, Roger M., Tran, Khanh Ngoc, Timmermann, Allan, Paye, Bradley Steele, Beason, Tyler Jorge |
| Publisher | Virginia Tech |
| Source Sets | Virginia Tech Theses and Dissertation |
| Language | English |
| Detected Language | English |
| Type | Dissertation |
| Format | ETD, application/pdf, application/pdf |
| Rights | In Copyright, http://rightsstatements.org/vocab/InC/1.0/ |
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