Analysis of topics in modern empirical finance

As the field of finance advances, it becomes increasingly important to re-evaluate existing beliefs to ensure that new techniques and ideas do not challenge them. This dissertation re-examines three of these topics in depth.; The first chapter deals with the Social Security system. Common perceptions hold that investing the trust fund into the stock market would save the Social Security system by capturing the equity premium that stocks enjoy over bonds. However, there exists a timing effect that makes the equity premium difficult for Social Security to capture. The pro-cyclicality of the stock market and Social Security's cash flows imply that when the Social Security system has the most money to invest, stock prices are at their highest. Similarly, when Social Security has the least to invest, stock prices are at their lowest. As a result, the benefits of stock investment for Social Security are overestimated. No such timing effect exists for bonds.; The second chapter analyzes the effects of index funding on the stocks in popular indexes. Investors and analysts feel that indexing has bloated the prices of stocks in the S&P 500 to unreasonably high levels, and as a result the indexing “craze” must soon burst like any other pricing bubble within the stock market. The analysis included shows that indexing has had no discernable impact on the companies in the S&P 500. Furthermore, the chapter shows that the widely identified stock price increase that companies enjoy when they enter the S&P 500 has an index-related liquidity effect, but only in the short term. Within a month, that effect reverses itself.; The third chapter studies the equity premium puzzle first identified by Mehra and Prescott in 1985. This empirical problem states that for reasonable parameterizations of the economy, a representative agent should demand a much higher risk-free rate, or require a much lower equity premium, than modern economies witness. This chapter reevaluates the original model by including a positive quantity of bonds in equilibrium. This refinement partially resolves the puzzle, and for risk-free rates larger than 2.7% the new framework rapidly expands the acceptable boundary for risk premia.