Essays on Financial Markets
Doctor of Philosophy
This dissertation contains three chapters. In the first chapter, I test whether margin requirements cause asset price volatility. Using novel data on margin requirements and by exploiting exogenous variation from a threshold-based regression discontinuity design, I document that increasing margin causes a persistent decrease in future volatility (negative level effect) and a decline in trading volume. For an average 13.7% increase in margin requirement, I find an average 3.7% decrease in volatility. These results contrast with prior empirical studies that largely find no relationship between volatility and margin and provide support for the efficacy of financial market policies that seek to curb excess market volatility. The second chapter tests whether removing these risk-retention requirements causes adverse selection in corporate CDO collateral pools. Using a natural experiment from a surprise 2018 legal ruling affecting a subset of the market, I find that bonds in CDOs with low "skin in the game" are riskier at issuance and become riskier after securitization, but find no evidence of increased at-issuance spreads. I also specifically show that issuers respond to a removal of regulations by increasing the risk profile of the CDO, but do not compensate senior (AAA) tranche holders. These results highlight the importance of risk retention requirements as a safeguard to prevent adverse selection in the corporate lending market. In the third chapter, I document two market dislocations that are caused by the creation of credit default swap indexes. Using exogenous variation around credit index inclusions, I show that the difference in credit default swap and cash bond spreads (known as the CDS-bond basis) is driven by variation in credit index inclusion. Each additional credit index inclusion is associated with a 15 basis point widening of the basis. I also document a spillover effect into equity securities of the included firms. When an index firm defaults, other index firms experience a negative 1.2% cumulative abnormal return. These returns fall by a further 10-15 basis points for each credit index inclusion.
finance; volatility; margin; credit default swaps; financial markets;