PhD Dissertations

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    Essays on pricing anomalies and the limits of arbitrage in emerging markets
    (2016-07) Şatıroğlu, Sait; Şener, Emrah; Akgiray, Ahmet Vedat; Department of Business; Şatıroğlu, Sait
    It is a difficult task to explain market anomalies in standard models of asset pricing, as they are all based on the core idea of the law of one price: two assets with equal expected returns have equal values. Otherwise, there is an arbitrage opportunity. However, arbitrage opportunities should not last for an extended period, as arbitrageurs should eventually locate the apparent mispricing, provide liquidity to markets, and keep prices in line with the asset's fundamentals. The Lehman crisis gives an opportunity to investigate both the behavioral and economic causes of deviations from the law of one price parity. Therefore, this dissertation thesis is focused on the empirical analysis of deviations from the law of one price parity using covered interest rate parity (CIRP) metric. It consists of three parts; the first two parts deal with the analysis of CIRP from different angles. The third part focused on finding an answer to the question, whether a market-based indicator created by the country-specific risk factors of CIRP deviations would be a major sign that can produce early warnings for the Turkish market. In the first chapter, I use the covered interest rate parity metric to measure violations of the law of one price parity (LOP) for currencies of developed and emerging economies. Across the five maturity point, I investigate both the time-series and cross-sectional variation of this LOP metric which severely violated during periods of financial distress. Dynamic factor analysis reveals that LOP deviations are time varying and state dependent for both markets and driven by two factors, namely: Global and Local factors. I construct empirical proxies for these factors and run a comprehensive investigation about economic drivers of this anomaly in three separate phases, pre-crisis, crisis (liquidity and credit crisis) and post crisis. My findings show that CIRP deviations on the global risk component and the country-specific risk components show distinct dynamics across developed and emerging countries. During the first phase of the crises, the global funding and liquidity factors are significant and shared to both markets, however, after the Lehman collapse while sentiment factors have a considerable impact on developed markets, the country-specific risk factors turn to be the main factors for emerging markets. In addition, financial contagion in developed markets, in terms of one way price discovery and volatility spillover does not appear to be valid for emerging markets CIRP deviations. Therefore, in the return and volatility levels, contagion in emerging countries indicate different local characteristics. The collapse of the recent housing price bubble brought the global economy to its knees and caused international funding liquidity to dry up. In the second chapter, I investigate how economic policies during the crisis impacted global liquidity by examining the covered interest rate parity condition. I find that swap lines orchestrated by the Federal Reserve, stress test announcements, and other governmental policies and news events had a significant impact on CIRP violations. My findings indicate that policies pursued during the crisis helped relieve market frictions in foreign exchange markets and that the result of these policies differed for developed and emerging markets. Most economists would argue that the seeds of the financial crisis were planted some time before the onset of the crisis. Hence, in the third chapter, I investigate whether the country-specific risk factors of CIRP deviations can be used as an early warning indicator for a local economy, namely Turkey, and create a blended index, so that regulators can be increasingly forward-looking hence pre-emptive rather than reactive in the century of high-speed information flow.