Essays in empirical asset pricing

I study questions related to risk premia in international equity markets and broad asset classes, and the role of financial intermediaries – market makers (dealers) and institutional investors – in shaping the price dynamics. This thesis consists of four essays. In the first essay, we study the importance of foreign institutional investors in the capital allocation process worldwide. We find that stocks that are held more by foreign institutional investors have more informative prices unconditionally and conditional on the same level of local institutional ownership. Foreign investors contribute to price informativeness about as much as local investors, especially for stocks in non-U.S. countries. The magnitude of the effect is robust to various endogeneity concerns. In the second essay, we use a unique transaction-level dataset on over-the-counter foreign exchange derivatives – forwards, swaps and cross-currency swaps – to study the failure of textbook no-arbitrage condition in FX markets, the covered interest rate parity (CIP). Empirically, we show that the newly introduced regulatory requirement on the balance sheet contributes to the violation of CIP. We solve the endogeneity issue by using an exogenous variation arising from the implementation of UK leverage ratio framework. In the third essay, we construct a strategy that buys securities with low past overnight returns and sell securities with high past overnight returns generates sizeable out-of-sample excess returns and Sharpe ratios. This strategy outperforms the conventional short-term reversal strategy for major international equity markets and futures written on equity indices, interest rates, commodities, and currencies. We find that the cross-sectional return volatility explains the returns from this strategy consistent with time-varying limits to arbitrage. In contrast, traditional risk factors fail to price these excess returns. In the last essay, we carry out the first cross-country analysis of the correlation risk premium. We examine the statistical properties of the implied and realized correlation in European equity markets and relate the resulting premium to the US equity market correlation risk and a global correlation risk factor. We find evidence of strong co-movement of correlation risk premia in European and US equity markets. The results support the hypothesis that a global correlation risk factor exists and that it is priced in international equity option markets. Finally, we document the relationship between the correlation risk premium on macroeconomic policy uncertainty and other uncertainty measures.