Three Essays in Financial Economics

Abstract

This dissertation contains three chapters concerned with questions in empirical and theoretical asset pricing.

This first chapter, Intangible Investment, Displacement Risk, and the Value Discount, explores how the composition of assets in place and growth opportunities affect risk premia. Firms with growth opportunities in the form of intangible investments exposed to displacement risk have larger expected returns than firms with growth opportunities in the form of tangible investments. I develop a production-based asset pricing model showing that a firms exposures to priced productivity and displacement risk depend on multiple firm characteristics. None of these characteristics alone can capture the firms total exposure. Empirically, intangible investment positively predicts returns, and firms undertaking more intangible investment are more exposed to proxies for displacement risk. I develop six proxies to measure displacement risk shocks: three based on sorting firms into portfolios and three based on aggregate variables. A portfolio double-sorted on two key firm characteristics, the bookto-market ratio (including intangible capital) and the difference between the intangible and tangible investment rates, produces large excess returns that existing models cannot explain. This double-sort can explain the decline of the Value Premium.

The second chapter, Identification of Factor Risk Premia, (joint with Peter Hansen) develops a novel statistical test of whether individual factor risk premia are identified from return data in multi-factor models. We give a necessary and sufficient condition for population identification of individual risk premia, which we call the kernel-orthogonality condition. This condition is weaker than the standard rank condition commonly assumed for linear factor models. Under misspecification, our condition ensures point identification of the risk premium with minimal pricing error. We show how to test this restriction directly in reduced-rank models. Finally, we apply our test methodology to assess identification of risk premia associated with consumption growth and intermediary leverage.

In the third chapter, Do Skilled Managers Improve Welfare? (joint with Ali Kakhbod) we consider a simple equilibrium model of active fund managers and consumers. Both managers and consumers are rational, and manager skill is measured by value added and not simply alpha. Positive value added managers do not necessarily increase consumer welfare. In our model, this is only true when the manager provides a hedge for the benchmark asset. The reason for this surprising result is that the negative correlation makes the manager and benchmark complementary “goods”. Managers need to be sufficiently skilled to offset the demand-induced price increases enough to improve welfare.