Essays in Financial Economics

The first chapter theoretically examines how substitutabilities across industry goods affect relative expected returns of industry portfolios. In an endowment economy in which two industries produce different goods, I show that an expanding industry demands relatively lower expected returns if the substitutability between the two industries' goods is low, and relatively higher expected returns if the substitutability is high. The key mechanism of the model is that when the substitutability between the two goods is low, a positive endowment shock to one industry raises the dividend value of the other industry more by raising the relative price of the good produced by the other industry. Hence, with a low substitutability, the relative consumption beta of an industry decreases with respect to its own shocks. As an industry grows, its endowment shocks become the major source of consumption risk, and therefore, its consumption beta and expected returns decrease relative to those of the other industry.;The second chapter empirically investigates the predictions of the first chapter using the nondurable and service consumption industries. The substitutability between nondurables and services is very low in the data. Consistent with the model predictions, the observed relative expected returns of the service industry decrease as the service industry grows. When calibrated under the assumption that services and nondurables have low substitutability, the model successfully explains the long-run movements in the relative expected returns between the nondurable and service industries.;The third chapter studies the long-run consumption risk reflected in news shock, a shock to expectations about future productivity. I identify news shock using a structural Vector Autoregression analysis. News shocks cause persistent future consumption growth and explain a large share of consumption movements in the long-run. Consistent with the long-run consumption risk hypothesis, I find that news shocks have a significantly positive risk premium in the cross section of asset returns. I also find that news shocks explain the size premium.