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This thesis improves the understanding of cryptocurrencies as financial assets by examining the Bitcoin reaction to high-frequency news compared to Forex, explores the role of news within financial markets, quantifies the economic value of a novel investment strategy which times financial noise able to manage price noise-risk, and assesses the extent to which climate change physical and transition risks are incorporated into asset prices. The thesis consists of three essays. The first essay "News sentiment in the cryptocurrency market: An empirical comparison with Forex" considers high frequency intra-day data to investigate the influence of unscheduled currency and Bitcoin news on the returns, volume and volatility of the cryptocurrency Bitcoin and traditional currencies over the period from January 2012 to November 2018. Results show that Bitcoin behaves differently to traditional currencies. Fiat currencies typically experience a decrease in returns after negative news arrivals and an increase in returns following positive news whereas Bitcoin reacts positively to both positive and negative news. This suggests investor enthusiasm for Bitcoin irrespective of the sentiment of the news. This phenomenon exacerbates during bubble periods. Conversely, cryptocurrency cyber-attack news and fraud news dampen this effect, decreasing Bitcoin returns and volatility. The second essay "The economic value of financial noise timing" proposes a dynamic noise-timing strategy which exploits the temporary dependence in noise traders' beliefs. Decomposing prices of the portfolio assets (stocks, bonds, gold, and cryptocurrencies) into permanent and noise components, we assess the economic value of a dynamic investment strategy which times the noise component. Our results show that risk averse and short horizon investors would be willing to pay a positive annual performance fee of between 314 and 940 basis points to switch from an ex-ante static investment strategy to a noise timing strategy. Our findings are robust to comparisons with other benchmark strategies, such as the volatility timing, and different periods of heightened volatility, including the Covid-19 period. The third essay "Transition versus physical climate risk pricing in euro area financial markets: A text-based approach" prices climate change risks in equity markets within a Fama-French five factor model. We build two novel vocabularies on physical and transition climate risks, and we construct a Physical Risk Index and a Transition Risk Index comparing them to a corpus of news over the period 2015-2019 using the cosine-similarity approach. Climate news are found to carry relevant information especially for brown firms, with transition risk appearing to be more concerning for investors. Returns of low environmental and ESG scores firms negatively relate to both shocks to physical and transition risk, whereas returns of high Greenhouse Gas emissions levels and intensity firms further decline with transition risk news. While investors appear to penalise high climate risk exposure, there is no evidence of an increase in returns of less exposed firms.

Standard finance theory portrays investors as rational utility maximisers. Persisting market anomalies and observed investor practice, however, have led to widespread recognition that the fundamental axioms of rationality are often violated. In response to the limitations inherent in standard theory, the Behavioural Finance approach relaxes the rationality assumption and takes account of psychological influences on individuals’ decision-making processes. Adopting the behavioural approach, this thesis, which includes two empirical studies, examines why, and to what extent, investors depart from rational or optimal investment practices. The thesis examines the effect of Myopic Loss Aversion (MLA) suggested by Benartzi and Thaler (1995) as a response to the Equity Premium Puzzle highlighted by Mehra and Prescott (1985). While previous studies are almost exclusively based on experiments in a laboratory setting, this approach provides more compelling empirical evidence by investigating the effects of MLA on real individual investors’ portfolio allocations through the use of the Dutch National Bank Household Survey. For the first time, the concept of MLA is identified through the interaction of two separate effects, firstly, individuals’ myopia, reflected in portfolio evaluation and rebalancing frequencies, and secondly, loss aversion. The thesis finds that individuals who are less affected by MLA invest more in risky financial assets. Further, individuals who are less myopic increase their share of risky assets invested in their financial portfolios over time, although this is unrelated to their loss aversion. These findings support the prediction of MLA theory that short investment horizons and high loss aversion lead to a significantly lower share of risky investments. In summary, the high equity premium can be explained by the notion of MLA. If individuals evaluate their investment performance over the long-term, they perceive much smaller risks relative to stockholding returns; consequently, they will be prepared to accept smaller equity premiums. The findings suggest possible interventions by policy makers and investment advisors to encourage individuals to remain in the stock market, such as providing long-term investment instruments, or restricting evaluation frequency to the annual reporting of investment performance. In response to the stockholding puzzle (Haliassos and Bertaut, 1995), this thesis also investigates individuals’ stock market returns expectations and their varying levels of risk aversion. Previous studies find that individuals’ heterogeneous stock market expectations determine variations in their stockholdings. The thesis accounts for the effect of risk aversion on stock market expectations, as well as on stockholding decisions. Additionally, the causality issue as between individuals’ expectations and stockholding status is controlled. The thesis finds that more risk averse individuals hold lower stock market expectations, and that the stock market return expectations of more risk averse individuals affect their stock market participation decisions negatively. The portfolio allocation decisions of individuals who already hold stocks are only affected by their expectations, with risk aversion being no longer significant. The thesis argues that persistent risk aversion effects cause individuals to hold pessimistic views of stock market returns, thus contributing to the enduring stockholding puzzle. The thesis reinforces existing perceptions that individuals in the real world may not make fully rational decisions due to their judgments which are based on heuristics and affected by cognitive biases. Individual investors often fail to maximise their utility given their preferences and constraints. Consequently, this thesis draws attention to the possible role of institutions, policy makers, and financial advisory bodies in providing effective interventions and guidelines to improve individuals’ financial decisions.

In recent years, the L-1 regularization has been extensively used to estimate a sparse precision matrix and encode an undirected graphical model. Because the regularized estimates are biased, the application of the graphical models has largely been restricted and has been ignored in many areas. In this work, we show that graphical models and their regularized estimates can be useful in the area of finance. We present our discussion in three parts. First, we propose a graphical representation model for the asset returns. The model captures observed variance in the equity market endogenously and offers a new perspective on the covariance estimation for asset returns. We show that such a model may provide a straightforward interpretation for investors regarding investment decision making. Second, we show that regularized estimates of graphical models, though biased, are useful to estimate the minimum variance portfolio and determine the portfolio rebalancing strategy. Third, we discuss the algorithms of solving one of the graphical models -- the graphical Concord. We present the software development process for the graphical Concord and illustrate the usage of the packages with some examples.

This dissertation explores how households allocate their financial resources across expenditure categories and over time. The interaction between income changes and consumption is important for the well-being of households. This interaction exhibits great heterogeneity across goods as well as across wealth. Notably, when the households are liquidity-constrained, their budget allocation decision is altered substantially. This dissertation analyzes the interaction between household income and intertemporal budget allocation with an emphasis on liquidity constraints.In the first chapter, I explore how the liquidity constraints affect the household intertemporal allocation of consumption differentially across wealth and across expenditure categories. This chapter comprises two sub-chapters for the theoretical and empirical evaluation of the effect of binding liquidity constraints on intertemporal budget allocation. Further, the chapter compares the effect of liquidity constraints on healthcare expenditure with the effect on non-health consumption in particular on food consumption. I extend a standard incomplete markets model with a health capital in the felicity function. Theoretically, I show that households reduce their healthcare expenditure due to the binding liquidity constraints in the current period, whereas expenditure declines in the next period due to the expected binding constraints one period ahead. I use the extended model to test the incidence of binding liquidity constraints with a linearized Euler equation. Empirically, I show that the test of liquidity constraints for healthcare expenditure reveals different implications than a standard test of liquidity constraints for nondurable consumption. In particular, current binding constraints and expected binding constraints lead to the opposite direction of bias when the liquidity constraints are omitted. The resulting overall bias depends on which constraint has a stronger effect. Moreover, the correlation between income and healthcare expenditure varies significantly between asset poor and rich families, more than the elasticity of non-health consumption among wealth quintiles. Altogether, my findings show that the effects of liquidity constraints are heterogeneous across households and across expenditure categories.In the second chapter, I estimate the income elasticity of consumption for various expenditures. Estimating income elasticity of consumption is found to be a challenging task. The causal impact of income changes on expenditure is hard to measure due to the endogeneity of the treatment variable income. I use a shift-share instrumental variable design `a la Bartik [1991] to mitigate the endogeneity concerns by exploiting variation due to local labor market exposure to aggregate shocks. I estimate the income elasticity of consumption that results from the changes in national employment growth in industries weighted with regional employment share of the industry. I find an average elasticity of total household consumption in the ranges between 0.4 to 0.53 depending on the construction of the instrument. Food consumption elasticity ranges between 0.11 to 0.2 though is not significantly estimated. Of particular interest for income elasticity estimates is the household out-of-pocket healthcare expenditure which has an elasticity of around 3.14 to 3.59. This finding adds to the discussion of health spending being a luxury good with an elasticity above one which is found in aggregate cross-country or time-series estimates. I find elasticities above one using household-level micro consumption and regional employment growth data, whereas micro studies usually conclude health expenditure elasticities around zero. In the third chapter, I provide a detailed analysis of household wealth and portfolio allocation. This chapter presents several stylized facts on how households allocate wealth among asset classes, how portfolio allocation changes over the lifecycle and over the business cycle, and how portfolio and income are related. The chapter combines various survey data to show that household income and portfolio allocation are highly correlated especially for middle-income households. Asset accumulation has an inverted-V shape over the lifecycle whereas debt is front-loaded in working ages. Income and consumption follow a hump-shaped over the lifecycle. Old households hold assets in liquid forms. As for the business cycle, the Great Recession has devastating effects on the welfare of households such that both networth and consumption declined, and poverty rates increased. The effect is more severe for non-white, low educated, and female-headed households.

Firms and investors often operate in environments with market imperfections and agency frictions. It is common wisdom that the effects of these microeconomic frictions are amplifed or mitigated by the quality of economic institutions in a country. Yet little is known about the precise channels through which institutions influence macroeconomic outcomes. The first chapter of this dissertation documents a novel stylized fact: countries with weaker institutions hold fewer foreign assets. It then highlights a new mechanism, the hedging of labor income risk in the presence of agency problems, by which weak institutional quality affects the composition of country asset portfolios. The second chapter looks at FDI in the form of mergers and acquisitions (MA) during the Asian Financial Crisis of 1997-98. We find evidence that crisis-time MA between foreign acquiring firms and domestic targets were of lower longevity in crisis-affected countries. Using a simple model of matching between acquiring and target firms, we then argue that this was due to reduced match quality during the crisis. The third chapter establishes a set of stylized facts about the relationship between institutional quality, macroeconomic volatility, firm size distribution, and financial development in a large cross-section of countries.