Essays on intra-market efficiency and financial contagion

The first essay of this dissertation shows that financial contagion risk is an important source of the risk premium. Intermediaries’ contribution to aggregate financial contagion is estimated in a new state space framework and a tradable financial contagion portfolio is formed. More contagious intermediaries earn excess returns over less contagious ones that cannot be explained by commonly used factor models. The relative performance of contagious intermediaries is also priced in the cross section of stock returns. Stocks that comove more strongly with contagious intermediaries earn monotonically greater returns. These results are robust to factor model specification, test assets, and time period considered. The second essay shows that exchange traded funds (ETFs) persistently trade at a premium to net asset value (NAV) and that market segmentation can explain this puzzling regularity. Tracking error standard deviation is used as the measure of market segmentation. ETFs with larger tracking error standard deviations trade at higher premiums, consistent with the notion that investors are willing to pay a premium to receive liquidity and diversification benefits from holding ETFs rather than the underlying securities directly. These results are robust to investor sentiment effects. Further tests validate that tracking error standard deviation has the desirable properties of a market segmentation measure. The third essay shows that previous studies substantially understate the magnitudes of arbitrage profits in the closed-end fund market. The assumption that closed-end fund returns depend only on current premiums is relieved in favor of returns being dependent on an optimally chosen history of premiums. Incorporating the information content of a fund’s premium innovation history substantially improves expected return estimates. In doing so, arbitrage profits are increased from an annualized 14.9 percent return with a Sharpe ratio of 1.519 to an 18.2 percent return with a Sharpe ratio of 1.918. These results are robust to a wide range of tests. They deepen the closed-end fund discount puzzle and pose a challenge to the market efficiency in these products.Ph. D.Includes bibliographical referencesIncludes vitaby Louis Richard Piccott