Essays on Market Speculators and Asset Prices

My dissertation aims to contribute to the understanding of speculative investors' trading behavior in asset markets and its implication to asset pricing.;In the first chapter, I test the hypothesis that the use of leverage by market speculators can increase the likelihood and magnitude of a crash in asset prices. I develop a novel methodology to measure a hedge fund's leverage ratio based on hedge funds' SEC filings over the sample period of 2001 to 2013. I find that stocks held by highly-levered hedge funds subsequently have more negatively skewed returns than stocks held by less highly-levered funds. This finding extends to the aggregate U.S. market index and is economically significant.;I further relate this effect to financial distress and find evidence that hedge funds taking high leverage are more likely to fire sell long positions when experiencing adverse economic events. That is, stocks held by highly levered hedge funds exhibit larger price declines during the time when there is a negative shock to the stock's fundamental value or when there is a negative shock to the aggregate funding liquidity, compared to stocks held by less levered funds. However, the larger price declines are partially reversed in the long run as the downward selling pressure fades away.;The second chapter tries to explain the cross-sectional heterogeneity in the amount of leverage that hedge funds take. That is, why do some hedge funds use more leverage, while some use less? I find that the convexity in fund managers' payoff function can lead to excessive risk-taking. I propose that an important and natural source of convexity is fixed operating costs. If a fund's assets under management dip below the threshold under which fees cannot cover its costs in the next period, then a fund's payoff function becomes convex, thereby leading to a gambling for resurrection phenomenon.;To test this hypothesis, I use the number of employees as a proxy for the amount of fixed operating costs. By measuring these fixed-cost-induced convexities with the ratio of a fund's fee revenue to the number of employees, I find a significantly negative correlation between hedge fund leverage and the ratio. Also, the effect appears to be stronger among funds that are more constrained to adjusting the size of their employment, such as extremely small hedge funds and funds located in the geographical regions where it is hard to hire investment talent.;In the third chapter (jointly with Harrison Hong), we develop a measure of binding short-sale constraints in equity markets based on speculators' trades. Our measure is derived from Chen, Hong, and Stein (2002)'s breadth of mutual fund ownership. We show that when the EXIT rate, the fraction of investors that held a stock in the previous quarter and that exit that stock this quarter, is high, short-sale constraints are more tightly binding and price is high relative to fundamentals. In contrast, entry of investors that have not previously owned the stock is associated with more not less over-pricing. The exit rate better captures the disagreement distribution of investors in similar fund styles actively evaluating a stock. Using the samples of equity funds and hedge funds, we show that stocks with high exit rates consistently under-perform the market throughout the entire 1980-2008 sample.