Financial Economics
Applied Econometrics

May 1998 (Oral) Econometrics, Industrial Organization
May 1997 (Written) Microeconomics and Macroeconomics

Essays on Capital Market Imperfections and Investment

Professor William Brainard
Professor Robert Shiller
Professor Peter Phillips

Summer 2001

M.Phil. in Economics, Yale University, 1999
B.Sc. in Mathematics and Statistics, Moscow State University, 1993

Yale Dissertation Fellowship, 2000
Cowles Foundation Prize, 1999
Yale University Fellowship, 1996-1998

Teaching Assistant, Financial Markets, Spring 2001, Yale University
Teaching Assistant, Introductory Microeconomics,1999/2000, Yale University

Research Assistant for Professors Steven Berry and Ariel Pakes, Yale University, 1999.
Created Gauss programs to perform sophisticated LDV estimation routines that had to be easy to understand and use; conducted extensive computer simulations to evaluate performance of BLP methods.
Intern, International Monetary Fund, Fiscal Affairs Department, Summer 1996
Processed U.K. National Income Account data and mortality tables to create social wealth series using FORTRAN code

• "Corporate Investment and Financing Constraints," job market paper, Yale University, 2000.
• "Financial Valuation of U.S. corporations: New Economy or Irrational Exuberance?" in progress.
• "Multi-Equation Model on NAIRU," mimeo, Yale University 1999.
• "Private Savings and Retirement Pensions: UK Experience," mimeo, IMF, 1996.

Efficient capital markets and rational agents are standard assumptions in economic models. Their implications, however, do not always fit well with empirical facts. In my dissertation, I use stock market and accounting data on a large panel of publicly traded U.S. firms to examine two issues often associated with capital market imperfections. My first essay studies the relation between financing constraints and fixed investment. The second essay analyzes fundamental versus market values of firms and provides a consistent methodology that can be used by practitioners to decide if a particular stock is overvalued.

In the first essay I conduct a firm-level empirical study of the interaction between investment and financing decisions by U.S. corporations. It is widely documented that firms’ cash flows and investments in physical capital are strongly correlated. A large body of empirical research supports the view that the observed correlation of investment and cash flows is due to the financing constraints. However, these studies have a serious shortcoming. Reduced form investment equations that involve the cash flow variable are routinely estimated in these studies to compare investment-cash flow sensitivities across different groups of firms. I show that making inference on the basis of investment-cash flow sensitivities alone can be misleading.

What distinguishes my study from previous research is that the empirical tests are based on a structural model of investment, which explicitly incorporates financing constraints. A reduced form investment equation obtained from the model links firm’s investments to its stock returns and cash flows. I give a structural interpretation to the parameters of the investment equation and suggest a better way of testing for the presence of financing constraints.

The estimation results of previous research are reevaluated from the perspective of this new approach. In sharp contrast to the conventional interpretation, I show that the results do not, in fact, provide any evidence of the presence of financing constraints. I also conduct new tests for the presence of financing constraints using an unbalanced panel of 4,000 U.S. corporations over the last 20 years that was not available to (or utilized by) other researchers. I use a wide variety of econometric procedures and tests but find no evidence of the presence of financing constraints.

In the second essay (in progress) I study a different empirical phenomenon, the extraordinary growth in securities markets in the U.S. over the last five years. To what extent can this growth be explained under the assumption of rational and efficient capital markets? Are there objective reasons for stock prices to be so high? Has the irrational optimism of the stockholders pushed the market values of U.S. corporations well above their fundamental values? There is a lot of anecdotal evidence that stocks are grossly overvalued but no careful and rigorous empirical study of this question has been done yet.

This paper analyzes a large panel of publicly traded U.S. firms and compares their fundamental values to the market values of their stocks. The fundamental value is the present discounted value of the expected earnings stream. The estimates of the expected earnings streams can be obtained from our own forecasts based on publicly available past accounting data or from market analysts’ forecasts. The discount factor consists of the pure rate-of-time discount appropriate to risk-free streams and the adjustment for risk (the risk premium). I examine cross-sectional evidence on the valuation of firms at different times to estimate the time discounts and risk adjustments necessary to explain observed market values. The panel data is ideally suited for the analysis of the effects of changes in the cross-sectional distribution of the risk premium. These effects would not be detected if aggregated data were used instead. I also examine whether the valuation patterns differ between ‘‘New Economy" sectors, such as computers and telecommunications, and traditional sectors.