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Essays in finance

Rong Qi, 2002
Faculty Advisor: Michael Adler
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This dissertation offers a microstructure-based model to explain two puzzles in finance: diversification discount and investment-cash flow sensitivity. While explicitly assuming that the stock prices convey valuable information to the firm's management, our model shows that the value loss from diversification is due to insufficient information production. Using the analyst coverage as the proxy for information production, we find holding firm characteristics fixed, the analyst coverage explains a significant portion of the cross-sectional variation in the diversification discount. The same model also predict the corporate investment-cash flow sensitivity will be stronger for firms with more informative stock prices, higher cash flow volatility and smaller divergence in opinions among the informed traders. These results cast doubt on the popular “financial constraints” hypothesis about the investment-cash flow sensitivity. Empirically, we find firms that are intensively covered by analysts have investment that is much more sensitive to cash flow than firms with less analyst coverage.

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