Brownian Excursions in Mathematical Finance

Zhang, You You (2014) Brownian Excursions in Mathematical Finance. PhD Thesis, LSE-UK.

The Brownian excursion is defined as a standard Brownian motion conditioned on starting and ending at zero and staying positive in between. The first part of the thesis deals with functional of the Brownian excursion, including first hitting time, last passage time, maximum and the time it is achieved. Our original contribution to knowledge is the derivation of the joint probability of the maximum and the time it is achieved. We include a financial application of our probabilistic results on Parisian default risk of zero-coupon bonds. In the second part of the thesis the Parisian, occupation and local time of a drifted Brownian motion is considered, using a two-state semi-Markov process. New versions of Parisian options are introduced based on the probabilistic results and explicit formulae for their prices are presented in form of Laplace transforms. The main focus in the last part of the thesis is on the joint probability of Parisian and hitting time of Brownian motion. The difficulty here lies in distinguishing between different scenarios of the sample path. Results are achieved by the use of infinitesimal generators on perturbed Brownian motion and applied to innovative equity exotics as generalizations of the Barrier and Parisian option with the advantage of being highly adaptable to investors’ beliefs in the market.

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A Dynamic Contagion Process for Modeling Contagion Risk in Finance and Insurance

Zhao, Hongbiao (2012) A Dynamic Contagion Process for Modeling Contagion Risk in Finance and Insurance. PhD Thesis, LSE-UK.

We introduce a new point process, the dynamic contagion process, by generalizing the Hawkes process and Cox process with shot noise intensity. Our process includes both self-excited and externally excited jumps, which could be used to model the dynamics of contagion impact from endogenous and exogenous factors of the underlying system. We systematically analyze the theoretical distributional properties of this new process, based on the piecewise-deterministic Markov process theory developed in Davis (1984), and the extension of the martingale methodology used in Dassios and Embrechts (1989). The analytic expressions of the Laplace transform of the intensity process and probability generating function of the point process are derived. A simulation algorithm is provided for further industrial implementation and statistical analysis. Some extensions of this process and comparison with other similar processes are also investigated. The major object of this study is to produce a general mathematical framework for modeling the dependence structure of arriving events with dynamic contagion, which has the potential to be applicable to a variety of problems in economics, finance and insurance. We apply our research to the default probability of credit risk and ruin probability of risk theory.

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Promotion, Finance and Mergers in Canadian Manufacturing Industry, 1885-1918.

Marchildon, Gregory Philip (1990) Promotion, Finance and Mergers in Canadian Manufacturing Industry, 1885-1918. PhD Thesis, LSE-UK.

The existing research on the first merger waves in the United States, Britain, and to a lesser extent in Germany, has produced valuable information on the rise of the modern industrial enterprise. These studies reveal important similarities as well as a few significant differences in the nature of the economic development of these nations. A new merger series for Canadian manufacturing industry was generated to provide a further comparison. In addition, a large pool of information was gathered concerning the workings of promotional syndicates, corporate flotation’s, and secondary financial markets. This aggregate data, in conjunction with a case study of the most prominent Canadian promoter of the era and the companies he consolidated, is used to determine the relationship between security financing and the evolution of manufacturing industry in Canada. An explanation of the cause of the first Canadian merger wave, 1909-1912, is based on individual case evidence and the results of causality tests using aggregate data. The necessary pre-condition to a merger wave was the emergence of a broad market for Canadian industrial securities. Although high stock prices stimulated merger waves in Britain and the United States at the turn of the century, the first Canadian merger wave had to wait another decade until the expansion of the Canadian market and the tapping of the British market for Canadian "industrials" permitted large-scale flotations. The potential profits which were available through corporate reorganization, rationalization of manufacturing and distribution networks, and monopolization, were reflected in the higher rates of return which British investors sought en masse in the new Canadian securities. This flood of British capital in turn accelerated the industrial transformation taking place in Canada and encouraged further mergers. High stock prices triggered the first merger movement as they had in Britain and the United States. Corporate financiers became merger promoters as they catapulted propositions into consolidations large enough to be listed on public stock exchanges and to be of interest to prospective investors. High-risk financial methods provided the incentive to financial intermediaries to broaden this market as quickly as possible and, therefore, to deliver the maximum amount of cash to the new industrial consolidations.

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Essays in Corporate Finance

Arcot, Sridhar Rao (2007) Essays in Corporate Finance. PhD Thesis, LSE-UK.

This thesis is divided into three chapters. Even though the three chapters have different aims, they all concerned with corporate finance. The first chapter concerns venture capital and chapters two and three deal with corporate governance. The first chapter deals with a special kind of security used in venture capital contracting -participating convertible preferred stock. Participating Convertible Preferred (PCP) stock is similar to convertible preferred stock but comes with participation rights. Participating rights allow the holder to participate in earnings along with common shareholders. PCPs play an important role in venture capital exits. The two major forms of exit observed in venture capital are initial public offerings (IPOs) and trade sale. Typically, a PCP stake is converted into common equity during an IPO exit but not converted in case of trade sales. We develop a model where VCs can signal the quality of their venture by costly conversion. We show that PCPs have the required features to implement the signaling mechanism. VCs signal by converting their PCP stake into common equity, when they exit from the venture and in the process give up some of their cash flow rights. We show that this can also help in alleviating the problem of entrepreneurial effort. Finally, we derive empirical implications for the two forms of exit. The second and third chapters are concerned with corporate governance. Firstly, we examine the effectiveness of the "comply or explain" approach to corporate governance in the UK. Using a unique database of 245 non-financial companies for the period 1998 - 2004. we perform a detailed analysis of both the degree of compliance with the provisions of the corporate governance code of best practice (Combined Code), and the explanations given in case of non-compliance. We rank the quality of explanations based on their information content. We find an increasing trend of compliance with the provisions of the Combined Code, but also a frequent use of standard and uninformative explanations when departing from best practice. We then use this data to analyze the extent of moral hazard problem in different groups of companies and the role of monitoring in alleviating it. The third chapter extends the above analysis. We use the dataset to identify well- governed companies by accounting for heterogeneity in their governance choices and investigate its association with performance. We find that companies that depart from governance best practice because of genuine circumstances outperform all others and cannot be considered badly-governed. On the contrary, we find that mechanical adherence to best practice does not always lead to superior performance. We thus argue that flexibility in corporate governance regulation plays a crucial role, because companies are not homogenous entities.

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An Essay in Corporate Finance: Managerial Incentives, Financial Constraints and Ownership Concentration.

Protopapa, Marco (2009) An Essay in Corporate Finance: Managerial Incentives, Financial Constraints and Ownership Concentration. PhD Thesis, LSE-UK.

I investigate the role of internal discipliners in the form of optimal equity ownership for the purpose of committing the management to the pursuit of shareholder value in the presence of separation between ownership and control. By rooting the conflicts of interests between managers and shareholders upon the control of internal funds, a simple model allows to analyze the link between profit uncertainty, growth options and decisional powers. I derive implications for the optimal degree of equity concentration, the effect of firm fundamentals on the allocation of income and control rights, and the pay for luck phenomenon. First, optimal equity ownership is positively related to the short-term performance of the firm and negatively related to both its growth options and riskiness. Second, optimal equity ownership is negatively related to the probability of the firm being financially constrained, in the sense that the level of desired investment exceeds internally available resources. Furthermore, I also show that straight debt alone does not implement the second best, in absence of a large shareholder. Finally, I show that, in presence of financial constraints, pay for luck is associated in equilibrium to a lower optimal degree of ownership concentration. In other words, pay for luck and looser governance, as implemented by the internal discipliner of equity concentration; emerge as the equilibrium result of a constrained incentive problem.

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Essays on Campaign Finance and Political Power

Fouirnaies, Alexander (2015) Essays on Campaign Finance and Political Power. PhD Thesis, LSE-UK.

This thesis is concerned with the influence of campaign finance on the interplay between political power and electoral competition in the United States and the United Kingdom. The thesis considers both the donation and expenditure sides of campaign finance: In the context of U.S. state and federal legislative elections (1980-2014), I study how political power affects the allocation of campaign contributions, and in the context of U.K. House of Commons elections (1885-2010), I examine how campaign spending restrictions affect political power via electoral behavior. The three papers which make up the construct of the thesis answer the following questions: (i) What is the financial value of incumbency status, and who generates it? (ii) Who values legislative agenda setters, and why do they do so? (iii) What are the electoral consequences of statutory limits on campaign expenditure? I argue that campaign donors make their contributions to powerful politicians in exchange for access to the policy-making process, and that the power of these politicians is sustained, at least in part, due to these contributions. In the first paper, I document that U.S. incumbent legislators enjoy sizeable financial advantages compared to challengers, and I demonstrate that this advantage is the result of donations from access-seeking industries. In the second paper, I show that U.S. legislators who are institutionally endowed with agenda-setting powers are given special treatment by campaign donors. I document that donors with vested economic interests in regulatory policy place great value on agenda-setting legislators – in particular when institutions provide these legislators with the authority to block new legislation. In the final paper, I study the consequences of campaign spending limits in the context of U.K. House of Commons elections. I show that unrestrained spending reduces electoral competition, promotes professionalized campaigns, and benefits incumbents and center right parties.

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Essays on Corporate Finance under Information Asymmetry

Liu, Xuewen (2007) Essays on Corporate Finance under Information Asymmetry. PhD Thesis, LSE-UK.

Essay 1: Stage Financing and Syndication in Venture Capital Investment: The combined use of stage financing and syndication is one of the most remarkable characteristics of venture capital financing. In particular, the majority of later-stage venture capital investments rather than early-stage are syndicated. The paper presents a theoretical rationale for this financial arrangement. The model shows that tight control (i.e. efficient refinancing or continuation/liquidation decision) of the venture capitalist by stage financing can achieve ex-post efficiency but may disincentivize the entrepreneur's effort provision ex-ante. Hence, the project value is not maximized. I show that the combined use of later-stage syndication with stage financing is a mechanism that can realize the optimal tradeoff between high effort ex ante and efficient continuation ex post thus maximizing project value. The model offers testable empirical predictions. Essay 2: The Capital Structure of Private Equity-backed Firms: In this paper I study one fundamental tension between venture capitalist and management in private equity-backed firms and show capital structure (of private equity-back firms) is a mechanism to resolve the tension. The paper gives rationale for several financial arrangements in private equity investment. (1) Private equity deals are typically partially outside financed even though the private equity fund may not be financially constrained at the deal level. (2) The optimal security for outside financing is debt. (3) The maturity of outside security is long-term. The insight of the paper has applications outside of private equity. Essay 3: Market Transparency and the Accounting Regime: We model the interaction of financial market transparency and different accounting regimes. This paper provides a theoretical rationale for the recently proposed shift in accounting standards from historic cost accounting to marking to market. The paper shows that marking to market can provide investors with an early warning mechanism while historical cost gives management a "veil" under which they can potentially mask a firm's true economic performance. The model provides new explanations for several empirical findings and has some novel implications. We show that greater opacity in financial markets leads to more frequent and more severe crashes in asset prices (under a historic-cost-accounting regime). Moreover, our model indicates that historic cost accounting can make the financial market more rather than less volatile, which runs counter to conventional wisdom. The mechanism shown in the model also sheds light on the cause of many financial scandals in recent years.

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The Foundations of Theoretical Finance

Theobald, Stuart (2016) The Foundations of Theoretical Finance. PhD Thesis, LSE-UK.

This thesis provides an account of the ontological, methodological and epistemological foundations of theoretical finance. I argue that these are linked: financial theory is not just a positive enquiry into the nature of the world, but also a means to engineer it. A core feature of its methodology is a modeling approach that conceives of risk as being identical with the volatility of financial market returns. I argue that this can be justified from the perspective of finance as a positive science, because it successfully points to some real features by using idealizations and simplifications. However, the study argue that this feature makes theoretical finance inadequate for the task of designing institutions in certain specific ways. The study also argue that the epistemic demands we make of models in the service of finance theory are different to the demands we should make of models that are used as blueprints for institutions. A failure to appreciate this difference contributed to the financial crisis and our failure to anticipate it. Finance theory has various effects on the financial system so is causally caught up in social ontology, a notion known as “performativity”. the study argue that financial theory and its models affect the workings of the financial system in three ways: they provide positive accounts of the financial system that individuals can learn from, they provide normative calculative devices to determine optimal decisions, and finally they provides blueprints for the design of financial institutions. The study have in the past assumed that models that succeed in supporting financial theories because of their coherence and validation by data will also be successful blueprints. However, good tests of blueprints should be inductive and assess for unexpected properties, quite unlike how the study test theory models. It follows that the study have insufficient reason to assume good theory models are good blueprints.

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Essays in Macroeconomics and Corporate Finance.

Perez, Ander (2008) Essays in Macroeconomics and Corporate Finance. PhD Thesis, LSE-UK.

This thesis consists of three essays at the intersection of macroeconomics and corporate finance. The broad theme that links the three chapters is the study of how endogenous borrowing constraints that affect firms and financial intermediaries influence aggregate investment. In Chapter I, the existing theoretical framework studying how financial constraints in firms may make economies more sensitive to shocks (the 'financial accelerator') is extended to take account of firms' precautionary investment behavior when they anticipate future liquidity constraints. This behavior is at the source of a powerful amplification mechanism of shocks, and is also able to account for the documented dynamics of the composition of investment across the business cycle: in particular how risky, illiquid investment as a share of total investment fluctuates both at the firm and at the aggregate level. Chapter II studies how the public supply of liquidity affects the private creation of liquidity by firms (inside liquidity), and how this interacts with firms' demand for liquidity to influence investment and capital accumulation. The conditions under which government debt may boost or reduce private investment are shown to depend on three channels: (1) a crowding-in effect, by enhancing aggregate liquidity, (2) a crowding-out effect, by reducing the collateral value of entrepreneurial assets and (3) a redistributive effect. The model also shows how a production economy with endogenous liquidity can help resolve some important asset pricing puzzles. Finally, the business cycle properties of the model are studied. Chapter III shows how recent developments in financial markets may have made economies less vulnerable to banking crises as they widen access to liquidity, but by relaxing financial constraints facing financial intermediaries, they imply that, should a crisis occur, its impact could be more severe than previously. These effects may be reinforced by greater macroeconomic stability. Finally, financial intermediaries are shown to under-insure and over-borrow from a constrained-efficient viewpoint.

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