Three Essays on Monetary and Financial Economics

This thesis contains three chapters on financial and macroeconomics.;Chapter 1 is an empirical study on what is referred to in the finance literature as “pairs trading”. Pairs trading involves simultaneous trades in two equity securities that have been identified as being very highly correlated historically. The idea is to trade the pairs when their prices diverge from another and to unwind the trade when their prices (hopefully) converge. The contribution of chapter 1 is to rigorously examine alternative techniques for identifying stock pairs. I consider two main techniques: a “distance” approach and cointegration. Each of these techniques is evaluated when pairs are selected within the same industry (“restricted pairs”) and when pairs are selected from the broad universe of stocks (“unrestricted pairs”). The main findings are that unrestricted pairs are preferred to restricted pairs for the distance approach and that restricted pairs work better for the cointegration approach, especially for the services, financial and retail trade sectors. In addition, the cointegration approach yields a higher excess return than the distance approach. Nevertheless, more risk-averse investors might prefer the distance approach based on my analysis of information ratios for the two approaches.;Chapter 2 is an empirical study of monetary policy in China. The main focus is identifying the effectiveness of alternative monetary instruments in affecting real economic activity. This chapter employs a structural vector autoregression (SVAR) methodology that is tailored to specific characteristics of the environment faced by Chinese policymakers—namely, exchange rate targeting, capital flow restrictions, and sterilization of the buildup of foreign exchange reserves. Briefly, we find that the money supply is an effective monetary instrument, while the interest rate is not.;Chapter 3 contains a theoretical model of bank runs. The main contribution is to show that bank runs—more broadly interpreted as financial instability—can arise purely from the joint interaction of business cycle fluctuations and ordinary consumption smoothing by households. To highlight this, chapter 3 shows that, in addition to classic panic-based bank runs, bank runs can be caused by a decrease in aggregate labor income, i.e., a recession.