Two essays in financial economics: I. Functional forms and pricing of country funds. II. Inflation, the Fisher equation, and term structure model of inflation risk premia. Theory and evidence from TIPS

My dissertation consists of two essays on mutual funds and term structure of interest rate. The purpose of this study is trying to understand investors' behavior from international markets through their investment horizon phenomenon, as well as investors' compensation for inflation risk through the term structure of inflation risk premium embedded from the pricing of TIPS.;Essay one examines the effect of heterogeneous investment horizons on portfolio choices in the global market. Traditional CAPM ignores the discrepancy between observed and true investment horizons. This paper proposes a generalized functional form CAPM model for pricing of international closed-end country funds. A comparison between share returns and NAV returns of closed-end country funds suggests that foreign investors, especially those from emerging markets, have more heterogeneous investment horizons compared to the U.S. counterparts. Market segmentation and government regulation do affect the market efficiency. No matter which model we use, the empirical evidence indicates that the risk-adjusted performance of international closed-end funds is negative even before expenses.;Essay two addresses the question as to what is compensation for investors' bearing inflation risk. In this paper, we study inflation risk and the term structure of inflation risk premia in the U.S. market using nominal interest rate and TIPS. We propose a two-factor CIR model with correlated real rate and inflation rate, and derive the closed form solution to our two-factor model through change of measure with solving a Riccati equation. The analytical formula facilitates the estimation of the model and enables us to estimate the term structure of inflation risk premia. We use Unscented Kalman Filter and MLE to estimate the model and explore the relationship between the real rate and the expected inflation rate from 1998 to 2004. The empirical evidence indicates that the implied inflation rate has a similar pattern with those derived from the consumer price indexes and the inflation risk premia demonstrate a steep term structure. Furthermore, we use our model to test the Fisher hypothesis and find that the Fisher hypothesis is supported in the short rates, but there exists a systematic upward bias for the longer maturity rates.