Three Essays in Financial Economics

This dissertation studies financial risk premia within different frameworks and asset classes. Part I develops a dynamic model with recursive preferences to study the risk premium embedded in crude oil markets. The oil risk premium is affected by risk aversion and intertemporal substitution parameters, and by the probability of entering a distressed state of the world in next period. We estimate this physical distress measure from the crude oil options market. If a distressed scenario unfolds, the total usage of oil for production purposes decreases, triggering an amplification mechanism throughout the economy which ultimately impacts the risk premium. We find that the oil risk premium is highly time-varying, increasing during recessive periods, and document a change in trend with the financialization of commodities era. We show that a preference for an early resolution of uncertainty is critical to generate the dynamics between investments and distress risk observed in the data. We also find that oil risk premia cannot be explained by market wide factors, and that estimated distress probabilities help predict business conditions. Part II specifies and estimates no-arbitrage models for sovereign CDS contracts by assuming that the country's default intensity depends on observable economic and financial indicators. We estimate these models using a sample of twenty-eight countries, three CDS maturities, and over a decade of daily data. The models provide a good fit. The impact of the economic and financial variables on spreads is consistent with economic intuition. Spreads increase as a function of stock market and exchange rate volatility, but decrease as a function of interest rates and stock market returns. Estimated risk premiums are highly time-varying and peak during the 2008 financial crisis for nearly all countries. For European countries, the risk premiums are also high during the Eurozone debt crisis. In periods of market stress and high CDS spreads, the increase in market risk premiums is even larger than the increase in default probabilities. Part III develops a dynamic framework with heterogeneous agents to study the effects of financial frictions on the distribution and dynamics of endogenously generated lending spreads over the riskless rate. Because of the interaction between counterparties, a small shock to the uncertainty of borrowers' prospects is amplified throughout the economy and has feedback effects on spreads. During these periods, default rates and lending spreads increase, while total lending decreases. Our model quantitatively rationalizes the observed linkage between economic and financial indicators. Model generated moments are consistent with economic indicators such as income, consumption, investment, and leverage ratios. These are also consistent with the levels and persistence of spreads. We find that in order to produce this amplification mechanism the model generates excess volatility of spreads, leading to a variant of the credit spread puzzle.Finance, Department o