Three essays in emerging markets
In this dissertation, I explore the pricing of idiosyncratic volatility in emerging markets and around the world. Additionally, I study the liquidity's effect on firm performance in the 2005's privatization in China. The first chapter examines the pricing of idiosyncratic volatility in the cross-section of stock returns in 24 emerging markets. As Ang, Hodrick, Xing, and Zhang (2009), I use the previous month's idiosyncratic volatility to proxy for expected idiosyncratic volatility. I establish that IV is indeed priced in emerging markets earning 0.35% per month in emerging markets and that IV is negatively related to future returns. Furthermore, I investigate the possible explanations for the pricing ability of IV in emerging markets and find liquidity bias is the main source of the pricing of idiosyncratic volatility. Either return reversal or growth option is not enough to explain the pricing ability in idiosyncratic volatility. The findings are robust to different measures of market return, the control of exchange rate risk, and the control of country characteristics. In the second chapter, I use the exponential GARCH model to estimate the expected idiosyncratic volatility and examines the pricing of the expected idiosyncratic volatility around the world. My estimate of the expected idiosyncratic volatility correct for the "look-ahead bias" in Fu's (2009) measure and I find lines of evidence consistent with Merton (1987). Specifically, I find that the expected idiosyncratic volatility is not priced in developed markets but it is positively priced in emerging markets where imperfect diversification is more likely to exist. Consistently, within emerging markets, the expected idiosyncratic volatility is only positively priced in the equal-weighted regressions but not in the value-weighted regressions. Furthermore, I show that the idiosyncratic volatility premium is only found in the firms with high transaction costs and small firm size. The findings are robust to various market and firm controls, different measure of market returns, and different models to estimate the idiosyncratic volatility. The third chapter explores the value effects of the most recent privatization efforts by the Chinese Government. Beginning in 2005, select state controlled companies relinquished control by offering previously non-traded equity for trading on the Shanghai and Shenzhen exchanges. I examine these first-time privatized firms and find that this event was associated with a positive and permanent improvement in price and most noticeably in the liquidity as measured by Amihud's price impact measure and by the bid-ask spread. I note an astonishing 90% improvement in the price impact of trade and a 60% reduction in the bid-ask spread for these firms subsequent to the privatization. I show that bonus shares, the main form of compensation plan, spur the liquidity in privatized firms and the liquidity improvements are associated with increases in firm value as measured by Tobin's Q. This association remains significant regardless of using the levels or changes in the underlying liquidity and firm value.