Three Essays on Asset Prices and Trading Behavior

My dissertation exams aggregate stock market behavior, the origin of financial crises, contagion between asset markets, and individual investor trading behavior.;In Chapter 1, I develop a dynamic equilibrium model that incorporates incorrect beliefs about crash risk and use it to explain the available empirical evidence on financial booms and busts. In the model, if a long period of time goes by without a crash, some investors' perceived crash risk falls below the true crash risk, inducing them to take on excessive leverage. Following a drop in fundamentals, these investors de-lever substantially, both because of their high pre-crash leverage and because they now believe future crashes to be more likely. Together, these two channels generate a crash in the risky asset price that is much larger than the drop in fundamentals. The lower perceived crash risk after years with no crashes also means that the average excess return on the risky asset is low at precisely the moment when any crash that occurs would be especially large in size; moreover, it means that, in the event of a crash, some investors may default and banks may sustain large unexpected losses. Finally, the model shows how pre-crash warning signs can generate financial fragility. By reducing investors' optimism, warning signs also increase investors' uncertainty about their beliefs and thereby make them more likely to overreact to future bad news.;In Chapter 2, I develop a dynamic general equilibrium model that studies how the presence of intermediaries can generate contagion between the aggregate stock market and the mortgage-backed security (MBS) market. In my model, households can directly access the aggregate stock market but can only access the MBS market through intermediaries; moreover, the intermediaries face an equity constraint due to financial frictions. I show that, under these assumptions, the contagion takes a particular form: when the amount of intermediary capital is modestly low, a price drop in the MBS market can lead to a significant price increase in the stock market; when the amount of intermediary capital is extremely low, a price drop in the MBS market can nevertheless lead to a significant price drop in the stock market.;Finally, in Chapter 3, Jon Ingersoll and I develop a tractable model of realization utility that studies the role of reference-dependent S-shaped preferences in a dynamic investment setting with reinvestment. Our model generates both voluntarily realized gains and losses. It makes specific predictions about the volume of gains and losses, the holding periods, and the sizes of both realized and paper gains and losses that can be calibrated to a variety of statistics, including Odean's measure of the disposition effect. Our model also predicts several anomalies including, among others, the flattening of the capital market line and a negative price for idiosyncratic risk.