Three Essays in Asset Pricing Dissertation Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Yoon Kang Lee, M.S. Graduate Program in Business Administration The Ohio State University 2018 Dissertation Committee Ingrid M. Werner, Co-Advisor Justin Birru, Co-Advisor Michael Schwert 1 Copyrighted by Yoon Kang Lee 2018 2 Abstract This dissertation is comprised of three chapters that aim to understand how the interactions between various investors and instruments in financial markets are linked to asset prices. In the first chapter, I study the impact of corporate bond ETF introductions on the liquidity of underlying bonds. I test the adverse selection and the arbitrage hypotheses which predict opposite effects of ETF introductions on underlying bonds. Consistent with the opposing predictions identified by theory, my overall results do not support either hypothesis in isolation. Examining differences in cross-sectional predictions of the hypotheses, I test the ETF-liquidity effect separately for high-yield and investment-grade instruments. In the investment-grade market, where the effect of the liquidity trader migration should be large, ETF bonds experience an additional decrease in trading intensity following the ETF inceptions, as predicted by the adverse selection hypothesis. By contrast, in the high-yield market where the effect of improvement in informational efficiency should be large, underlying bonds experience an additional increase in trading intensity following the ETF inceptions, confirming the countervailing liquidity effects of the ETF introduction. The positive ETF-liquidity effect in the high-yield market mainly appears for bonds where ETFs own a higher proportion, while the negative ETF-liquidity effect in the investment-grade market is less dependent upon ETF ownership. ii The second chapter studies financial constraints to professional arbitrage stemming from irrationality of its providers of capital. I find that market-wide idiosyncratic volatility is an important funding constraint to professional arbitrage. After controlling for other proxies for market-wide and strategy-level constraints to arbitrage, increases in market idiosyncratic volatility reduce short selling of stocks associated with value and momentum strategies. Moreover, this negative relationship comes from hedge fund flow sensitivity to market-wide idiosyncratic volatility: Increases in market-wide idiosyncratic volatility reduce flows to long/short equity hedge funds, and these outflows work as a restriction to short selling associated with anomaly strategies. However, hedge fund flow sensitivity to the strategy-level idiosyncratic volatility does not affect professional arbitrage associated with that strategy. These results are consistent with hypotheses that professional arbitrage is constrained by the money flows stemming from end investors’ concern about market- wide uncertainty, rather than their aversion to the uncertainty of the invested portfolio itself. In the third chapter, I study how market participants, including short sellers, react to a company’s share repurchases that follow an increase in the position held by short sellers. Using future returns to disentangle the different motives for share repurchases following increases in the positions held by short sellers , I find that firms buy back a large number of shares to credibly signal undervaluation in the face of short selling pressure. Subsequent short sales do not increase more in this case, which implies that short sellers facing the conflicting trades correctly react to the repurchases. On the other hand, firms without short selling pressure do repurchase a large number of shares to support price, and short sellers subsequently increase their position to properly react to the signal of overvaluation. iii Dedication Dedicated to my parents and sister. iv Acknowledgments I would like to express my sincere appreciation to my co-advisors, Ingrid M. Werner and Justin Birru, for their continual support and invaluable guidance. I am deeply indebted to their comments, encouragement, commitment, and patience throughout the six years of my Ph.D. program. I would also like to thank my dissertation committee, Michael Schwert, for his advice and guidance. I am also grateful to René M. Stulz for his insightful comments. I thank my friends for their encouragement and friendship. I am also thankful to Robyn Scholl for supporting me throughout my Ph.D. studies. I would like to thank my family. They have always been there for me with their unconditional love. I am especially grateful to my parents, who supported me to chase my dream. My sister and grandmother deserve my wholehearted thanks as well. I want to share my happiness and gratitude with my grandfather in heaven. v Vita 2009 ............................................................... B.B.A. Business Administration & B.A. Economics, Seoul National University 2011 ............................................................... M.S. Statistics, Stanford University Fields of Study Major Field: Business Administration Area of Specialization: Finance vi Table of Contents Abstract ............................................................................................................................... ii Dedication .......................................................................................................................... iv Acknowledgments............................................................................................................... v Vita ..................................................................................................................................... vi List of Tables ..................................................................................................................... ix List of Figures .................................................................................................................... xi Introduction ......................................................................................................................... 1 Chapter 1 Corporate bond ETF inceptions and liquidity of the underlying bonds ............. 5 1.1 Introduction ............................................................................................................. 5 1.2 Corporate bond ETFs: background and structure ................................................. 15 1.3 Related theories and testable hypotheses .............................................................. 17 1.4 Data description .................................................................................................... 25 1.5 Liquidity measures and empirical design ............................................................. 31 1.6 Empirical results ................................................................................................... 36 1.7 Conclusion ............................................................................................................ 56 Chapter 2 Professional money management, exposure to market uncertainty, and limits to short-sales ................................................................ ......................................................... 74 2.1 Introduction ........................................................................................................... 74 2.2 Data description .................................................................................................... 80 2.3 Empirical design ................................................................................................... 87 2.4 Empirical results ................................................................................................... 90 2.5 Conclusion .......................................................................................................... 100 Chapter 3 Why do firm managers repurchase following short interest increases? ......... 112 3.1 Introduction ......................................................................................................... 112 3.2 Hypotheses and predictions ................................................................................ 117 vii 3.3 Data description and empirical design ................................................................ 120 3.4 Empirical results ................................................................................................. 128 3.5 Conclusion .......................................................................................................... 138 Bibliography ................................................................................................................... 146 viii List of Tables Table 1.1 Sample Construction Procedure ........................................................................ 58 Table 1.2 Corporate Bond Summary Statistics ................................................................. 59 Table 1.3 Liquidity Measures Before and After ETF Inception ....................................... 60 Table 1.4 Pooled Regressions with ETF Initiations in Isolation ...................................... 62 Table 1.5 Liquidity Effects of Investment-Grade ETF Initiations .................................... 63 Table 1.6 Liquidity Effects of Investment-Grade ETF Initiations (Small transactions) ... 64 Table 1.7 Liquidity Effects of High-Yield ETF Initiations .............................................. 65 Table 1.8 Liquidity Effects