Three Essays on Finanical Economics

Abstract

This thesis discusses network risk and its implications for financial economics. A stock’s tendency to co-move with its related stocks is defined as network risk. In the first chapter, I propose a new econometric procedure to estimate network risk using a factor model and show that network risk is not negligible in the 2007-2008 financial crisis. The second chapter examines the pricing of network risk in the cross section of stock expected returns. Using the Fama-McBeth regression, I show that a newly-derived network volatility component of idiosyncratic volatility, termed NVOL, was priced with a 1.01 percent monthly premium between Sep. 1967 and Dec. 2012. This finding suggests a risk-based explanation of the equity premium: Stocks are compensated for risk that arises from shocks to networks that contain them. Finally, the third chapter summarizes various systemic risk measures developed after the financial crisis in 2008. These measures are classified into four categories: (1) Tail dependence; (2) Default probability; (3) Network measure; and (4) Others based on their approach and data required. Robust-yet-Fragile property which is one of the characteristics of a modern financial system is identified as a key to understanding the cascade effects of systemic risk. Network based systemic risk models have great potential to capture this property, both theoretically and empirically.