Essays on pricing models in economics and finance.

Abstract

This dissertation is a collection of two essays on pricing models in the following markets: the securities market and the consumer-good market. The first essay is 'The role of capital structure in tests of asset pricing models.' This essay examines the effect of capital structure of firms in the cross-sectional tests of average equity returns and the time-series tests of the predictability of equity returns. The analysis shows that the capital structure effect may be the source of the relation between average equity returns, size, and book-to-market value. The capital structure effect may also be the cause of continuation in the medium horizon and reversal in the long horizon of equity returns. The empirical test results reveal that 50% of the relation between size, book-to-market value, and average equity returns is explained by the capital structure effect. The results also show that 80% of reversal in the long horizon and 30% of continuation in the medium horizon of equity returns are due to the capital structure effect. There remains, however, economically significant equity return continuation in the medium horizon unexplained. The second essay is 'The preference of the rich and famous: a theory of conspicuous consumption.' This essay explains why some goods are purchased for conspicuous consumption at prices significantly above producer's marginal costs even with no barriers to entry into the market. Our explanation relies on modeling conspicuous consumption as a signaling game in which wealthy individuals consume conspicuously as a way to signal their wealth to society in order to obtain higher social status. This essay addresses the fact that signaling-motivated consumption must be conspicuous and the very act of consuming these goods has a discrete cost attached to it. It is showed that a signaling equilibrium with price can arise in a utility-maximizing framework in which the single-crossing-property condition holds. Results show that the higher the cost of display, the more likely is the consumer to signal by purchasing high-price conspicuous goods. The lower the free display units available, the higher the equilibrium prices of the conspicuous good. This essay also examines characteristics that determine which goods qualify for signaling-motivated conspicuous consumption. It is shown that goods with higher variability of consumption utility in the cross-section of consumers are accepted as conspicuous goods at higher prices that those with lower variability when their cross-sectional mean utilities are equal.