Essays in empirical asset pricing
The first essay is about interest rate swap. Existing models of the term structure of interest rate swap yields assume a unique regime for the data generating process and ascribe variations in swap-Treasury yield spread to default risk or to liquidity premium. However, the interest rate swap market has been marked by economic events and institutional changes that might have significant effects on the data generating process, and thus on the relationship between the swap spread and its determining factors. We investigate the stability of the relationship between the swap spread and its determining factors with the structural change econometric techniques of Bai and Perron (1998). The structural change tests produce endogenous break dates and associated confidence intervals. We trace the break dates to events related to liquidity, default, and institutional changes in the swap market. We find that default risk is an important source of variation of the swap spread at the beginning of the sample period, but is relatively less important at the end. Liquidity is, by contrast, more important towards the end of the sample period. Since these results call into question the assumption of one regime, we propose and estimate a joint Treasury and swap term structure model that accommodates regime switching. Evidence from the maximum likelihood estimation provides considerable support for the regime switching model. Consequently, the implied swap spreads may differ greatly across regimes.
The second essay, a joint work with Professor Maria Vassalou, deals with corporate innovation. We define corporate innovation (CI) as the proportion of a firm's change in gross profit margin not explained by the change in the capital and labor it utilizes. We show that CI contains important information about expected equity returns. This information is very different from information contained in earnings surprises variables. It is however strongly related to the information contained in past returns, and can explain much of the performance of price momentum strategies.