Essays on financial intermediation

Kim, M (2019) Essays on financial intermediation. Doctoral thesis, University of London: London Business School.

Abstract

This thesis is structured around two main chapters that study how financial intermediaries affect asset prices and real economic activity of firms. In the first chapter, I study how mutual fund managers affect asset prices due to two types of risk they have to face: fund flow risk and liquidity risk. Uncertain fund flows affect managers' income and may force managers to liquidate their asset holdings even when the liquidating cost is high. I present an equilibrium model with fund flow risk and liquidity risk, with two types of investors: delegated managers and direct investors. The model implies that expected returns are driven by two factors: market beta adjusted for liquidity and fund flow beta. The fund flow beta measures how a stocks returns and liquidating costs co-move with unexpected aggregate fund flows. I empirically test the model and find that the implied stochastic discount factor explains the average returns of 50 size, book-to-market, liquidity, and flow beta portfolios jointly and separately. In fact, the fund flow beta subsumes the liquidity-adjusted market beta across different model specifications. Moreover, the magnitude of the price of risk for fund flow beta is very similar across the different sets of test assets, supporting the prediction that aggregate innovations in fund flows are an important component of the stochastic discount factor. Conditional on liquidity risk, the fund flow risk premium is 3.17% for illiquid stocks and 1.74% for liquid stocks annually. The second chapter studies how the supply of foreign bank loans affects debt financing and subsequently the real investment and employment of non-financial firms in 70 different countries using bank-firm level data. I exploit the Lehman Brothers bankruptcy as a shock to a bank's health during the 2008 financial crisis, measured by the change in the number of loans made by the bank to all firms during the crisis relative to the pre-crisis period. I instrument the bank's health using the pre-crisis share of the revolving facilities co-syndicated with Lehman Brothers. Using the instrument, I find that firms with a high share of foreign bank loans do not decrease debt financing, real investment, and employment as much as firms with a low share of foreign bank loans during the negative foreign loan supply. This points to a mechanism in which firms with a high foreign loan share substitute to local loan or bond financing at the expense of firms with a low foreign loan share which are crowded out from the local debt market.