Essays in Financial Economics

Abstract

In the first essay, I study stock price movements during the trading day and find that retail trading activity generates excess intraday volatility. I develop a simple econometric measure which reveals that volatility realized during the trading day is too high to be reconciled with volatility achieved over the entire trading day. High intraday volatility stocks temporarily outperform low intraday volatility stocks by approximately 59 basis points over the next month. This temporary outperformance is due to retail investor price pressure, which I identify using the detailed brokerage dataset of Barber and Odean (2000) as well as a novel time-series dataset obtained from parsing the financial statements of Charles Schwab and E TRADE. The second essay considers how tax-motivated selling generates temporary distortions in stock prices around the turn of the tax year. As investors face the trade-off between selling a temporarily-depressed stock this year and selling next year but delaying tax implications by one year, the magnitude of the stock's price distortion is a function of its cost basis, the capital gains tax rate, and importantly, the interest rate. Each of these components explains variation in US stock returns as well as retail investor selling behavior around the turn of the tax year. Similar results in the UK provide out-of-sample confirmation, as tax and calendar years differ. The third essay develops a real business cycle model with time-varying inflation risk and optimal, but infrequent, capital structure choice. In the model, more volatile inflation or more procyclical inflation leads to quantitatively important increases in credit spreads. Intuitively, this result obtains because inflation persistence generates large uncertainty about the price level at long maturities and because firms cannot adjust their capital structure immediately. Across a panel of six developed economies, credit spreads rise by iii Abstract iv 15 basis points if either inflation volatility or the inflation-stock return correlation increases by one standard deviation. Firms counteract higher debt financing costs by adjusting their capital structure in times of higher inflation uncertainty.