Essays in Financial Economics

Abstract

This dissertation studies three different topics in financial economics.

The first chapter investigates how a profit-maximizing asset originator can coordinate the information acquisition of and interaction among investors with different expertise by means of asset bundling. Bundling is beneficial to the originator when it discourages investors from analyzing idiosyncratic risks and focuses their attention on aggregate risks. But it is optimal to sell aggregate risks separately in order to exploit investors' heterogeneous expertise in learning about them and thus lower the risk premium. This analysis rationalizes the common securitization practice of bundling loans by asset class, which is at odds with existing theories based on diversification. The analysis also offers an alternative perspective on conglomerate formation (a form of asset bundling), and its relation to empirical evidence in that context is discussed.

The second chapter, coauthored with Cheng Chen, proposes and provides empirical support for a novel explanation for the middle income trap: political distortion intensifies with economic development and impedes further growth. A parsimonious model is built to highlight the tradeoff faced by the policy maker between public interest of economic development and private interest of special interest groups. The latter dominates the former when the economy is good, as special interest groups benefit disproportionately from economic development and tilt policy making towards them by providing greater political rents. We use empirical evidence from the historical episode of the removal of branching restriction of U.S. banking industry to support our hypothesis.

The third and last chapter studies the contract design implication of routine auditing. In real life, usually people routinely pay accounting firms upfront before the publication of the financial reports of a firm being audited. I show in a model that otherwise resembles Gale and Hellwig (1985) that the optimal contract is equity instead of debt. This contrasts many existing security design models and points out state contingency of auditing technology is the driving force of their result.