Essays in economics and finance [electronic resource]

This dissertation focuses on the study of two main elements. First, I study the effect on financial decisions by local governments of different fiscal federalism arrangements at the supranational or federal level. In the first chapter, I develop a framework to analyze a risk sharing mechanism similar to the one employed among governments in the European Monetary Union, namely a bailout fund. This institutional setup produces strategic behavior and negative externalities in default and debt between countries. I develop a quantitative model of sovereign default with strategic interaction to estimate the welfare losses of these externalities. I contrast these with those generated by another risk sharing mechanism widely used among governments, fiscal centralization. Centralization tends to produce smaller welfare losses than a bailout fund. However, in both cases, the correction of the externalities would lead to Pareto improvements. The model rationalizes the detachment of sovereign credit risk from idiosyncratic macroeconomic variables. It suggests that in Europe, the link of this risk to global factors is related to the presence of the bailout fund and moral hazard. A correction of the latter would lead to a reduction of the correlation of sovereign yields and external macroeconomic variables. Finally, the model replicates the positive conditional correlation found in the data between yields on sovereign bonds of European countries and debt to GDP ratios of other countries in the monetary union. The second element of study of the dissertation, is the effect of taxes on the financial decisions of firms. In the second chapter, I develop a dynamic stochastic model of capital formation at the firm level, and use the asset price approach to study the incidence of a tax reform in Mexico in 2007 under which a tax on assets was eliminated and a tax on payments to factors of production was introduced. Under the latter, there is a higher degree of risk sharing between the government and firms. However, using simulated method of moments estimators I find that the rate that firms use to discount investment projects does not change with the reform. The reform leads to an increase in wages, capital formation and stock prices of capital intensive firms, while it implies a reduction in these variables for labor intensive firms. The effects of taxes on financial decision are also studied in the third chapter which was written jointly with Frédéric Panier and Francisco Pérez-González. We show that capital structure significantly responds to changing tax incentives. To identify the effect of taxes, we exploit the introduction of a novel tax provision (the notional interest deduction, or NID) as an arguably exogenous source of variation to the cost of using equity financing. The NID, introduced in Belgium in 2006, drastically reduces the tax-driven distortions that favor the use of debt financing by allowing firms to deduct from their taxable income a notional interest charge that is a function of equity. Our main findings are four. First, the NID led to a significant increase in the share of equity in the capital structure. Second, both incumbent and new firms increase their equity ratios after the introduction of the NID. Third, the largest responses to these changing tax incentives are found among large and new firms. Fourth, the increase in equity ratios is explained by higher equity levels and not by a reduction in other liabilities. The results are robust to using data from neighboring countries as a control group, as well as relying on a battery of tests aimed at isolating the effect of other potential confounding variables. Overall, the evidence demonstrates that tax policies designed to encourage the use of equity financing are likely to lead to more capitalized firms. In summary, the dissertation focuses on understanding the implications of different financial arrangements between the public sector and private and public agents. The recent financial crisis has showed that government decisions have important implications for risk allocation and financial decisions across other governments as well as the private sector. This dissertation sheds light on what these implications are. The complexity of the economic and financial relationships between the public and private sector led me to relate this dissertation to several fields such as Corporate Finance, Asset Pricing, Public Economics, Macroeconomics, and International Finance. Therefore, the techniques used across the document are very diverse: macroeconomic modelling, structural estimation, and reduced form empirical strategies. This heterogeneity across fields and techniques reflects my conviction that the intricacies of the discipline of Economics require a deepening in the interaction and understanding across fields.

Keywords: Economics.
Advisor: Piazzesi Monika primary advisor. Thesis advisor
Boskin Michael J. advisor. Thesis advisor
Scheuer Florian advisor. Thesis advisor
Schneider Martin (Professor of economics) advisor.