Essays on Empirical Asset Pricing

Ho, Thang and Kagkadis, Anastasios and Wang, George (2022) Essays on Empirical Asset Pricing. PhD thesis, Lancaster University.

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Abstract

This thesis is a collection of three essays corresponding to the three research projects I undertook in the area of empirical asset pricing and institutional investors. In the first essay, we show that a simple and intuitive variable, the return of a bear spread portfolio orthogonalized with respect to the market (H-Bear factor), can serve as an important pillar for explaining the cross-section of hedge fund returns. Low H-Bear exposure funds (bear risk insurance sellers) outperform high H-Bear exposure funds (bear risk insurance buyers) by 0.58% per month on average, outperform even during market crashes, but underperform when bear market risk materializes. Overall, we identify a new risk dimension that affects hedge fund performance, and we show that this risk factor is distinct from the already popular realized tail risk. The second essay analyzes the impact of firm-level political risk on individual equity option. We document a political risk premium of about 0.30% per month in the equity option market. High-political risk firms exhibit delta-hedged option returns that are significantly lower than those of low-political risk firms. The effect holds both in a cross-sectional and in a time-series context. Further, the political risk-option return relation is more pronounced among firms with high option demand, high information asymmetry, and high default probability, while it is mitigated for politically active firms. The demand pressure for the options of politically risky firms is driven by the call purchases of public customers and the put purchases of firm proprietary investors. Hence, it appears that due to its heterogeneous nature firm-level political risk is treated differently by different investor groups. In the third essay, we investigate the effect of climate change exposure on mutual fund performance. In the presence of rising concern about climate change that potentially affects risk and return of investors’ portfolio companies, active investors might have dispersed climate risk exposures. We compute mutual fund covariance with market-wide climate change news index and find that high (positive) climate beta funds outperform low (negative) climate beta funds by 0.24% per month on a risk-adjusted basis. High climate beta funds tilt their holdings toward stocks with high potential to hedge against climate change. In the cross section, such stocks yield higher excess returns, which are driven by greater pricing pressure and superior financial performance over our sample period.