This dissertation examines two issues on financial stability. The first essay investigates the impact of the growth of mutual funds industry on the stock and bond market stability. The assets of equity and bond mutual funds have recently grown rapidly. There is fear that a fall in stock and bond prices will cause widespread redemptions of mutual funds, reinforcing the fall in stock or bond prices, ending in a downward death spiral. This essay employs statistical procedures to test the causality between the mutual fund flows and the stock and bond market returns, and to test whether mutual fund flows affect market volatilities. Our findings suggest, first, that the recent run-up in stock prices cannot be attributed to the rapid growth of equity mutual funds, and, second, that we cannot rule out the possibility of a mutual-fund-induced downward price spiral in the down stock market.
The Second essay examines the margin policy and the safety of the futures clearinghouse. The clearinghouse is the guarantor of the futures market. In providing the performance guarantee to investors, the clearinghouse bears the risk that the investors might default. The margin requirement is a major tool for the clearinghouse to minimize its exposure to the default risk. In this paper, performance guarantee is priced and an explicit formula for setting margin requirements is proposed using option pricing theories. Our empirical work examines the factors that determine the margin levels. We also document the strong impact of the competition among futures exchanges on their margin setting behavior.