Essays in Financial Economics

Abstract

This dissertation studies the linkages between financial intermediaries and capital

markets. In particular, it analyzes potential sources of instability originating from the

intermediary sector.

Chapter 1, "Countercyclical Bank Equity Issuance," studies capital structure dynamics

of intermediaries over the credit cycle. I show that during credit booms, banks

raise less equity (i.e. countercyclical equity issuance), even though more equity might

help banks better absorb shocks. I argue that government guarantees distort the incentives of banks to raise equity and thus play a crucial role in driving banks' countercyclical equity issuance. My findings help explain why banks may resist raising equity during credit expansions, making financial distress more likely.

Chapter 2, "Credit Expansion and Neglected Crash Risk," co-authored with Wei

Xiong, studies the role of bank shareholders in credit booms and financial crises. This

chapter tests different theories of the causes and consequences of credit expansions

through the lens of asset prices and highlights the role of over-optimism and neglect of

crash risk by bank shareholders.

Chapter 3, "Risk and Return in High Frequency Trading," co-authored with Jonathan

Brogaard and Andrei Kirilenko, studies a very different type of financial intermediary,

high-frequency traders. Using a new proprietary, firm-level dataset, we show that

high-frequency traders have strong incentives to take liquidity in financial markets and

compete over small improvements in speed.