Three essays on financial markets

This thesis consists of three essays on financial market theory. The first paper explores stock market dynamics with rational liquidity traders. The second and the third paper are on bank competition on providing bank services—ATM (Automated Teller Machines) service and in-branch service. In the second paper, we explained why banks ‘rip off’ customers by charging high fees for accessing non-member ATMs. And in the third paper, we show that banks competition generate excessive ATM concentration.; The first paper is motivated by a seminal paper by Kyle [1985]. In the Kyle [1985] finite horizon model of stock market dynamics with a trader who holds long-lived information, informed trading intensities rise with time, and the slopes of the equilibrium price schedules fall. This paper shows that this result depends crucially on the irrational liquidity trader assumption. We replace the irrational noise traders with a sequence of rational, risk averse, liquidity traders who receive endowment shocks to their holdings of the risky asset. We demonstrate that unless liquidity traders are sufficiently risk averse, the slope of equilibrium pricing schedule rises over time, while informed trading intensities fall. In particular, Kyle's result holds only when liquidity traders are so risk averse that they “over-rebalance” their portfolio's holdings of the risky asset, so that their final holdings of the risky asset have the opposite sign of their initial position.; In the second paper, we develop a spatial model in which we endogenize both the pricing of ATM services by banks and the choice of home bank and ATM use by consumers. The equilibrium delivers the empirical regularities: Banks set high bank account fees for their own customers, but do not charge them for ATM usage; in contrast, banks charge high ATM fees for non-member users, fees that exceed those levels that would maximize ATM revenues from non-members; and larger banks set higher account fees and demand higher surcharges for ATM use than smaller banks. Paradoxically, we find that (i) A bank's ATM revenues may fall short of its costs of ATM provision; and (ii) Prohibiting banks from surcharging non-members, by forcing banks to charge members and non-members the same ATM price, leads to higher ATM prices, greater bank profits and reduced consumer welfare.; In the last paper, we develop a new spatial model in which we endogenize the choice by banks of both ATM concentration and the pricing of banking services. Consumers first choose a bank at which to establish an account and then when they receive banking service demand shocks choose whether to obtain the service from their member or non-member bank's ATM. Banks choose equilibrium ATM concentrations that are socially excessive. Banks have an incentive to create excessive ATM density because they can extract profits more efficiently from their own customers through bank account fees than from ATM use by customers of other banks, and a bank's greater ATM concentrations raise the attraction of establishing an account with the bank. This prediction is consistent with the enormous increase in the number of ATMs in the past decade, an increase that far exceeded the increase in ATM use. Equilibrium pricing also matches the empirical regularities: banks set high bank account fees for their own customers but do not charge them for ATM usage; in contrast, banks charge high ATM fees for non-member users.