ESSAYS IN BANKING AND FINANCE: SECURITIZATION, SYSTEMIC RISK AND HEALTHCARE REFORM by GANG DONG A dissertation submitted to the Graduate School - Newark Rutgers, The State University of New Jersey in partial fulfillment of the requirements for the degree of Doctor of Philosophy Graduate Program in Management Written under the direction of Professor Darius Palia and approved by _________________________ _________________________ _________________________ _________________________ Newark, New Jersey May, 2012 © 2012 Gang Dong ALL RIGHTS RESERVED ABSTRACT OF THE DISSERTATION Essays in Banking and Finance: Securitization, Systemic Risk and Healthcare Reform By GANG DONG Dissertation Director: Professor Darius Palia This dissertation includes three essays. The first essay identifies the determinants of bank’s risk contribution to systemic risk, and documents that banks with higher non- interest income (noncore activities like investment banking, venture capital and trading activities) have a higher contribution to systemic risk than traditional banking (deposit taking and lending). After decomposing total non-interest income into two components, trading income and investment banking and venture capital income, we find that both components are roughly equally related to systemic risk. These results are robust to endogeneity concerns when we use a difference-in-difference approach with the Lehman bankruptcy proxying for an exogenous shock. We also find that banks with higher trading income one-year prior to the recession earned lower returns during the recession period. No such significant effect was found for investment banking and venture capital income. The second essay analyzes the effect of mortgage securitization on the real economy and housing market. I estimate the dynamic response of housing risk and real GDP to shocks of mortgage securitization and banks’ ownership of mortgage-backed security (MBS), and test three hypotheses suggested in the extant literature. Using ii structural vector autoregression (SVAR) methodology and cross-sectional analysis, I find that securitization reduces housing risk by completing the market. Interestingly, housing risk increases when commercial banks’ ownership of MBS increases. This positive relationship is inconsistent with the agency view of securitization but is consistent with the neglected risk view of mortgage securitization (Gennaioli, Shleifer, and Vishny 2011). The causal inference is drawn from a quasi-experimental design using housing data of bordering CBSA regions in neighboring states with and without the passing of anti- predatory lending laws. The third essay identifies the passing of the Patient Protection and Affordable Care Act (PPACA) as an exogenous shock and uses the event study method to estimate the stock market’s reaction in terms of asset price changes in the health care sector. The stock market appears to view the passing of PPACA as good news to the home care and specialty outpatient services but bad news to the medical instrument and health insurance industries. This might suggest that the existing institutional structure of the insurance industry is biased against comprehensive health, and most growth opportunities exist in the home care and specialty outpatient services. Furthermore, the magnitude of the abnormal return is relatively larger for firms with higher profit and R&D investment, but smaller for firms held by healthcare-specialized institutional investors, which is consistent with the literature that price changes are partially due to information revelation efforts by sophisticated institutional investors. iii ACKNOWLEDGEMENTS I would like to thank the members of my dissertation committee for their active involvement in the entire process. I am especially indebted to my advisor, Professor Darius Palia, for his endless guidance and support of my academic endeavors. Professor Palia is one of the main reasons I became interested in banking and financial economics, and I have learned so much from him over the years. Professor Palia has become one of my closest mentors and collaborators over the past few years. Working with him has been a real inspiration and I look forward to many more collaborations with him in the future. I would also like to thank my other committee members. Professors Jin-Mo Kim and Yangru Wu have provided so many opportunities and have opened countless doors for me throughout my graduate studies here. Their wise advice and guidance have shaped not only my dissertation, but my entire research agenda. And finally, I would like to thank my outside committee member, Professor Markus Brunnermeier, for taking an interest in my research and pointing me in the right direction both in terms of research and my career. Additionally, I would also like to give many thanks to the other members of the Finance and Economics faculty who have helped to make my graduate experience both challenging and rewarding: Professor Ivan Brick, Professor Simi Kedia, Professor C.F. Lee, Professor Avri Ravid, Professor Tavy Ronen, Professor Carlos Seiglie, and Professor Norman Swanson. My research here at Rutgers Business School would not have been possible without the support of the Whitcomb Center for Research in Financial Services. In iv addition, I would also like to thank the Graduate School-Newark and Rutgers Business School for summer research funding and dissertation fellowship. I would also like to thank everyone involved in the Ph.D. in Management program here at Rutgers Business School, especially Dr. Glenn Shafer and Assistant Dean Goncalo Filipe. Additionally, I am very grateful to have had the opportunity to get to know and work with all of my colleagues and classmates. Furthermore, I would like to express my sincere appreciation to two individuals who, although were not on my committee, provided so many opportunities and has opened countless doors for me throughout my graduate studies: Professor N.K. Chidambaran of Fordham University and Professor Graciela Chichilnisky of Columbia University. Finally, I would like to thank my wife for standing beside me throughout my career and writing this dissertation. v TABLE OF CONTENT ABSTRACT OF THE DISSERTATION ........................................................................... ii ACKNOWLEDGEMENTS............................................................................................... iv TABLE OF CONTENT..................................................................................................... vi LIST OF TABLES...........................................................................................................viii LIST OF FIGURES ........................................................................................................... xi CHAPTER 1: Banks’ Non-Interest Income and Systemic Risk......................................... 1 1.1 Introduction......................................................................................................... 1 1.2 Related Literature................................................................................................5 1.3 Data, Methodology, and Variables Used ............................................................ 7 1.3.1 Data............................................................................................................. 7 1.3.2 Systemic Risk using ∆CoVaR .................................................................... 8 1.3.3 Systemic Risk using SES.......................................................................... 12 1.3.4 Independent Variables.............................................................................. 15 1.4 Empirical Results.............................................................................................. 17 1.5 Conclusions....................................................................................................... 25 Appendix A: Quantile Regression ................................................................................ 26 Appendix B: Names of Banks in the Top Quartile....................................................... 29 CHAPTER 2: Mortgage Securitization: The Good, the Bad, or the Irrelevant? .............. 47 2.1 Introduction....................................................................................................... 47 2.2 Related Literature..............................................................................................51 2.3 Hypotheses........................................................................................................ 55 2.3.1 Securitization is Optimal........................................................................... 55 vi 2.3.2 Securitization is Detrimental..................................................................... 57 2.3.3 Securitization is Irrelevant ........................................................................ 60 2.4. Data................................................................................................................... 60 2.5 Methodology..................................................................................................... 64 2.5.1 Time-series Analysis................................................................................. 64 2.5.2 Cross-sectional Analysis........................................................................... 75 2.5.3 Quasi-experimental Design....................................................................... 78 2.6 Results..............................................................................................................