Essays on integration vs. segmentation of financial markets

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Zhang, Teng
Eun, Cheol S.
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Essay I: Uniform Mortgage Regulation and Distortion in Capital Allocation The U.S. economy is significantly influenced by local features, but most federal policies are national. In this essay, I study the unintended consequences of the uniformity of the national conforming loan limit (CLL) before 2008 on bank lending in local jumbo mortgage markets. When the national CLL increased, the jumbo share of residential mortgage markets in low-income counties was significantly reduced relative to high-income counties. I find that banks responded to the exogenous national shock by significantly increasing jumbo approval rates in low-income counties. The economic magnitude is large: a county with a \$10,000 lower median income is associated with, on average, a 6 percentage-point (or 11.77\%) higher jumbo loan approval rate compared to a county with a \$10,000 higher median income. The results are not driven by credit supply changes, borrower quality changes, home price anticipation, or the demand channel. Consistent with the competition mechanism in which lenders expand jumbo credit to defend market share, I also find that banks in low-income counties lower jumbo mortgage rates and later suffer from worse mortgage performance. Furthermore, smaller and less informed banks expand jumbo credit more aggressively, and, as a result, riskier borrowers receive more credit. Overall, my results highlight negative consequences of the uniformity of federal policy in mortgage markets by showing how it can lead to distorted bank lending and reduce efficiency of credit allocation across regions. Essay II: Housing Market Integration and Economic Convergence In this essay, I find that the increasing housing market integration in recent decades has contributed significantly to the convergence of output, income, and total employment growth across U.S. states. States with integrated housing markets also converge in their utilization of the home equity line of credit and in the prevalence of real-estate secured loans, which suggests the collateral channel as a key transmission mechanism through which housing market integration contributes to the economic convergence. To establish causality, I identify exogenous variations in state-level house prices using real estate related foreign direct investments that are orthogonal to state economic conditions. My findings are robust to controls for banking integration and geographic proximity, and are not driven by the performance of the real estate industry or changes in local demand. I also obtain similar results at the MSA level. Essay III: Global Diversification with Local Stocks: A Road Less Traveled In this essay, I document a great heterogeneity in the degree of global financial integration at the firm-level and delve into its implications for international portfolio diversification. Specifically, I estimate the degree of integration for about 14,000 sample firms per year, on average, from major developed markets over the period 1995-2014, using the R-square method. The key findings are: (i) The R-square, our measure of integration, is very widely distributed across sample firms, within and across countries; (ii) The firm-level integration is significantly affected by the three attributes tested – country, industry, and style; style exerts the greatest effect, followed by country and industry; (iii) `Local' stocks that are least driven by the common global factors are significantly more effective in portfolio risk diversification than either domestic or `global' stocks; this result holds during the recent global financial crises; (iv) Systematically identifying local stocks and holding them optimally, investors can significantly benefit from the enhanced the mean-variance efficiency within the familiar confines of developed markets. In light of the stark heterogeneity in global integration at the granular level, inferences of the diversification gains solely from stock market indices, the usual practice, are likely to understate the potential gains that world stock markets can provide.
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