Essays in financial economics

In the three chapters comprising this dissertation, I explore some issues regarding financial institutions and financial markets. In the first chapter, I present a model that examines (institutional) herding in rational financial markets. In this model, I attribute a resource allocation role to stock prices. When informed investors possess private information important to a firm's investment decision, they need to transmit it to the firm manager. A natural way to achieve this is by trading in a way that allows the manager to infer their information. However, when their trading patterns affect firm investments, there is an incentive to generate the pattern the manager responds to. In most models of rational expectations, such manipulation results in trading losses and can be supported only by imposing market incompleteness or restricted participation. However, with a real effect, just giving investors positive inventory leads to potential herding as investors can recoup their trading loss through the value increase of their inventory. Also, price manipulation in my model is value increasing since informed investors generate investment-affecting patterns only when the resulting investment is desirable.; The second chapter examines institutional investment in firms issuing seasoned equity (SEO firms). I document that institutional investors significantly increase their investments in SEO firms compared to those in non-issuing firms with identical characteristics. Also, SEO firms with the greatest increase in institutional investment outperformed their benchmark portfolios the most over one-year and two-year horizons after the issue. There is no such relationship for non-issuing firms. I interpret the results in Chapter 2 as evidence that institutional investors are able to identify above average SEO firms at the time of equity issuance, and increase their holdings in these potential outperformers.; In the third chapter, I examine so-called “momentum” strategies that have been suggested as evidence of predictability in stock returns based upon past returns. I conjecture that firms in growth industries are harder to value, and thus systematic misvaluation will more pervasive in such firms; hence, these firms will exhibit greater momentum. To test this conjecture, I investigate momentum profits for individual stocks split into quintiles along the dimension of industry growth. I find that individual stock momentum varies almost monotonically by industry growth. Firms in highest industry growth quintile have significantly higher momentum compared to those in the lowest growth quintile. I also separately investigate momentum profits for two groups of firms within each industry growth quintile: those with asset growth above the industry average, and those below the average. I find that the above-average growth group within each quintile has significantly higher momentum profits than the below-average group. Further, momentum profits of the highest industry growth quintile are always higher than those for the universe of firms, suggesting an economic benefit to stratifying firms based on industry growth and relative company growth intra-industry, while following a momentum investment strategy.