Three essays on the psychology of investment and financial markets

Préface My thesis consists of three essays where I consider equilibrium asset prices and investment strategies when the market is likely to experience crashes and possibly sharp windfalls. Although each part is written as an independent and self contained article, the papers share a common behavioral approach in representing investors preferences regarding to extremal returns. Investors utility is defined over their relative performance rather than over their final wealth position, a method first proposed by Markowitz (1952b) and by Kahneman and Tversky (1979), that I extend to incorporate preferences over extremal outcomes. With the failure of the traditional expected utility models in reproducing the observed stylized features of financial markets, the Prospect theory of Kahneman and Tversky (1979) offered the first significant alternative to the expected utility paradigm by considering that people focus on gains and losses rather than on final positions. Under this setting, Barberis, Huang, and Santos (2000) and McQueen and Vorkink (2004) were able to build a representative agent optimization model which solution reproduced some of the observed risk premium and excess volatility. The research in behavioral finance is relatively new and its potential still to explore. The three essays composing my thesis propose to use and extend this setting to study investors behavior and investment strategies in a market where crashes and sharp windfalls are likely to occur. In the first paper, the preferences of a representative agent, relative to time varying positive and negative extremal thresholds are modelled and estimated. A new utility function that conciliates between expected utility maximization and tail-related performance measures is proposed. The model estimation shows that the representative agent preferences reveals a significant level of crash aversion and lottery-pursuit. Assuming a single risky asset economy the proposed specification is able to reproduce some of the distributional features exhibited by financial return series. The second part proposes and illustrates a preference-based asset allocation model taking into account investors crash aversion. Using the skewed t distribution, optimal allocations are characterized as a resulting tradeoff between the distribution four moments. The specification highlights the preference for odd moments and the aversion for even moments. Qualitatively, optimal portfolios are analyzed in terms of firm characteristics and in a setting that reflects real-time asset allocation, a systematic over-performance is obtained compared to the aggregate stock market. Finally, in my third article, dynamic option-based investment strategies are derived and illustrated for investors presenting downside loss aversion. The problem is solved in closed form when the stock market exhibits stochastic volatility and jumps. The specification of downside loss averse utility functions allows corresponding terminal wealth profiles to be expressed as options on the stochastic discount factor contingent on the loss aversion level. Therefore dynamic strategies reduce to the replicating portfolio using exchange traded and well selected options, and the risky stock.

Catastrophic medical expenditure risk

Medical expenditure risk can pose a major threat to living standards. We derive decomposable measures of catastrophic medical expenditure risk from reference-dependent utility with loss aversion. We propose a quantile regression based method of estimating risk exposure from cross-section data containing information on the means of financing health payments. We estimate medical expenditure risk in seven Asian countries and find it is highest in Laos and China, and is lowest in Malaysia. Exposure to risk is generally higher for households that have less recourse to self-insurance, lower incomes, wealth and education, and suffer from chronic illness.

Detecting Heterogeneous Risk Attitudes with Mixed Gambles

We propose a task for eliciting attitudes toward risk that is close to real-world risky decisions which typically involve gains and losses. The task consists of accepting or rejecting gambles that provide a gain with probability p and a loss with probability 1−p . We employ finite mixture models to uncover heterogeneity in risk preferences and find that (i) behavior is heterogeneous, with one half of the subjects behaving as expected utility maximizers, (ii) for the others, reference-dependent models perform better than those where subjects derive utility from final outcomes, (iii) models with sign-dependent decision weights perform better than those without, and (iv) there is no evidence for loss aversion. The procedure is sufficiently simple so that it can be easily used in field or lab experiments where risk elicitation is not the main experiment.

Loss of Cutaneous TSLP-Dependent Immune Responses Skews the Balance of Inflammation from Tumor Protective to Tumor Promoting.

Inflammation can promote or inhibit cancer progression. In this study we have addressed the role of the proinflammatory cytokine thymic stromal lymphopoietin (TSLP) during skin carcinogenesis. Using conditional loss- and gain-of-function mouse models for Notch and Wnt signaling, respectively, we demonstrate that TSLP-mediated inflammation protects against cutaneous carcinogenesis by acting directly on CD4 and CD8 T cells. Genetic ablation of TSLP receptor (TSLPR) perturbs T-cell-mediated protection and results in the accumulation of CD11b(+)Gr1(+) myeloid cells. These promote tumor growth by secreting Wnt ligands and augmenting β-catenin signaling in the neighboring epithelium. Epithelial specific ablation of β-catenin prevents both carcinogenesis and the accumulation of CD11b(+)Gr1(+) myeloid cells, suggesting tumor cells initiate a feed-forward loop that induces protumorigenic inflammation.

Treatment-dependent loss of polyfunctional CD8+ T-cell responses in HIV-infected kidney transplant recipients is associated with herpesvirus reactivation.

Antiretroviral-therapy has dramatically changed the course of HIV infection and HIV-infected (HIV(+)) individuals are becoming more frequently eligible for solid-organ transplantation. However, only scarce data are available on how immunosuppressive (IS) strategies relate to transplantation outcome and immune function. We determined the impact of transplantation and immune-depleting treatment on CD4+ T-cell counts, HIV-, EBV-, and Cytomegalovirus (CMV)-viral loads and virus-specific T-cell immunity in a 1-year prospective cohort of 27 HIV(+) kidney transplant recipients. While the results show an increasing breadth and magnitude of the herpesvirus-specific cytotoxic T-cell (CTL) response over-time, they also revealed a significant depletion of polyfunctional virus-specific CTL in individuals receiving thymoglobulin as a lymphocyte-depleting treatment. The disappearance of polyfunctional CTL was accompanied by virologic EBV-reactivation events, directly linking the absence of specific polyfunctional CTL to viral reactivation. The data provide first insights into the immune-reserve in HIV+ infected transplant recipients and highlight new immunological effects of thymoglobulin treatment. Long-term studies will be needed to assess the clinical risk associated with thymoglobulin treatment, in particular with regards to EBV-associated lymphoproliferative diseases.

Recurrent loss of heterozygosity in 1p36 associated with TNFRSF14 mutations in IRF4 translocation negative pediatric follicular lymphomas.

Pediatric follicular lymphoma is a rare disease that differs genetically and clinically from its adult counterpart. With the exception of pediatric follicular lymphoma with IRF4-translocation, the genetic events associated with these lymphomas have not yet been defined. We applied array-comparative genomic hybridization and molecular inversion probe assay analyses to formalin-fixed paraffin-embedded tissues from 18 patients aged 18 years and under with IRF4 translocation negative follicular lymphoma. All evaluable cases lacked t(14;18). Only 6 of 16 evaluable cases displayed chromosomal imbalances with gains or amplifications of 6pter-p24.3 (including IRF4) and deletion and copy number neutral-loss of heterozygosity in 1p36 (including TNFRSF14) being most frequent. Sequencing of TNFRSF14 located in the minimal region of loss in 1p36.32 showed nine mutations in 7 cases from our series. Two subsets of pediatric follicular lymphoma were delineated according to the presence of molecular alterations, one with genomic aberrations associated with higher grade and/or diffuse large B-cell lymphoma component and more widespread disease, and another one lacking genetic alterations associated with more limited disease.

Loss of ability to work and ability to live independently in Parkinson's disease.

OBJECTIVE: Ability to work and live independently is of particular concern for patients with Parkinson's disease (PD). We studied a series of PD patients able to work or live independently at baseline, and evaluated potential risk factors for two separate outcomes: loss of ability to work and loss of ability to live independently. METHODS: The series comprised 495 PD patients followed prospectively. Ability to work and ability to live independently were based on clinical interview and examination. Cox regression models adjusted for age and disease duration were used to evaluate associations of baseline characteristics with loss of ability to work and loss of ability to live independently. RESULTS: Higher UPDRS dyskinesia score, UPDRS instability score, UPDRS total score, Hoehn and Yahr stage, and presence of intellectual impairment at baseline were all associated with increased risk of future loss of ability to work and loss of ability to live independently (P ≤ 0.0033). Five years after initial visit, for patients ≤70 years of age with a disease duration ≤4 years at initial visit, 88% were still able to work and 90% to live independently. These estimates worsened as age and disease duration at initial visit increased; for patients >70 years of age with a disease duration >4 years, estimates at 5 years were 43% able to work and 57% able to live independently. CONCLUSIONS: The information provided in this study can offer useful information for PD patients in preparing for future ability to perform activities of daily living.

Hypoxia/hypoglycemia preconditioning prevents the loss of functional electrical activity in organotypic slice cultures.

In cerebral ischemic preconditioning (IPC), a first sublethal ischemia increases the resistance of neurons to a subsequent severe ischemia. Despite numerous studies, the mechanisms are not yet fully understood. Our goal is to develop an in vitro model of IPC on hippocampal organotypic slice cultures. Instead of anoxia, we chose to apply varying degrees of hypoxia that allows us various levels of insult graded from mild to severe. Cultures are exposed to combined oxygen and glucose deprivation (OGD) of varying intensities, ranging from mild to severe, assessing both the electrical activity and cell death. IPC was accomplished by exposure to the mildest ischemia condition (10% of O2 for 15 min) 24 h before the severe deprivation (5% of O2 for 30 min). Interestingly, IPC not only prevented delayed ischemic cell death 6 days after insult but also the transient loss of evoked potential response. The major interest and advantage of this system over both the acute slice preparation and primary cell cultures is the ability to simultaneously measure the delayed neuronal damage and neuronal function.

Loss of connexin40 is associated with decreased endothelium-dependent relaxations and eNOS levels in the mouse aorta.

Upon agonist stimulation, endothelial cells trigger smooth muscle relaxation through the release of relaxing factors such as nitric oxide (NO). Endothelial cells of mouse aorta are interconnected by gap junctions made of connexin40 (Cx40) and connexin37 (Cx37), allowing the exchange of signaling molecules to coordinate their activity. Wild-type (Cx40(+/+)) and hypertensive Cx40-deficient mice (Cx40(-/-)), which also exhibit a marked decrease of Cx37 in the endothelium, were used to investigate the link between the expression of endothelial connexins (Cx40 and Cx37) and endothelial nitric oxide synthase (eNOS) expression and function in the mouse aorta. With the use of isometric tension measurements in aortic rings precontracted with U-46619, a stable thromboxane A(2) mimetic, we first demonstrate that ACh- and ATP-induced endothelium-dependent relaxations solely depend on NO release in both Cx40(+/+) and Cx40(-/-) mice, but are markedly weaker in Cx40(-/-) mice. Consistently, both basal and ACh- or ATP-induced NO production were decreased in the aorta of Cx40(-/-) mice. Altered relaxations and NO release from aorta of Cx40(-/-) mice were associated with lower expression levels of eNOS in the aortic endothelium of Cx40(-/-) mice. Using immunoprecipitation and in situ ligation assay, we further demonstrate that eNOS, Cx40, and Cx37 tightly interact with each other at intercellular junctions in the aortic endothelium of Cx40(+/+) mice, suggesting that the absence of Cx40 in association with altered Cx37 levels in endothelial cells from Cx40(-/-) mice participate to the decreased levels of eNOS. Altogether, our data suggest that the endothelial connexins may participate in the control of eNOS expression levels and function.

Conversion of membrane-bound Fas(CD95) ligand to its soluble form is associated with downregulation of its proapoptotic activity and loss of liver toxicity.

Human Fas ligand (L) (CD95L) and tumor necrosis factor (TNF)-alpha undergo metalloproteinase-mediated proteolytic processing in their extracellular domains resulting in the release of soluble trimeric ligands (soluble [s]FasL, sTNF-alpha) which, in the case of sFasL, is thought to be implicated in diseases such as hepatitis and AIDS. Here we show that the processing of sFasL occurs between Ser126 and Leu127. The apoptotic-inducing capacity of naturally processed sFasL was reduced by >1,000-fold compared with membrane-bound FasL, and injection of high doses of recombinant sFasL in mice did not induce liver failure. However, soluble FasL retained its capacity to interact with Fas, and restoration of its cytotoxic activity was achieved both in vitro and in vivo with the addition of cross-linking antibodies. Similarly, the marginal apoptotic activity of recombinant soluble TNF-related apoptosis-inducing ligand (sTRAIL), another member of the TNF ligand family, was greatly increased upon cross-linking. These results indicate that the mere trimerization of the Fas and TRAIL receptors may not be sufficient to trigger death signals. Thus, the observation that sFasL is less cytotoxic than membrane-bound FasL may explain why in certain types of cancer, systemic tissue damage is not detected, even though the levels of circulating sFasL are high.

Improvement in coronary circulatory function in morbidly obese individuals after gastric bypass-induced weight loss: relation to alterations in endocannabinoids and adipocytokines.

AIMS: To investigate the effect of surgical gastric bypass-induced weight loss and related alterations in endocannabinoids (ECs) and adipocytokine plasma levels on coronary circulatory dysfunction in morbidly obese (MOB) individuals. METHODS AND RESULTS: Myocardial blood flow (MBF) responses to cold pressor test (CPT) from rest (ΔMBF) and during pharmacologically induced hyperaemia were measured with &supl;³N-ammonia PET/CT in 18 MOB individuals with a body mass index (BMI) > 40 kg/m² at baseline and after a median follow-up period of 22 months. Gastric bypass intervention decreased BMI from a median of 44.8 (inter-quartile range: 43.3, 48.2) to 30.8 (27.3, 34.7) kg/m² (P < 0.0001). This decrease in BMI was accompanied by a marked improvement in endothelium-related ΔMBF to CPT and hyperaemic MBFs, respectively [0.34 (0.18, 0.41) from 0.03 (-0.08, 0.15) mL/g/min, P = 0.002; and 2.51 (2.17, 2.64) from 1.53 (1.39, 2.18) mL/g/min, P < 0.001]. There was an inverse correlation between decreases in plasma concentrations of the EC anandamide and improvement in ΔMBF to CPT (r = -0.59, P = 0.009), while increases in adiponectin plasma levels correlated positively with hyperaemic MBFs (r = 0.60, P = 0.050). Conversely, decreases in leptin plasma concentrations were not observed to correlate with the improvement in coronary circulatory function (r = 0.22, P = 0.400, and r = -0.31, P = 0.250). CONCLUSIONS: Gastric bypass-related reduction of BMI in MOB individuals beneficially affects coronary circulatory dysfunction. The dysbalance between ECs and adipocytokines appears to be an important determinant of coronary circulatory function in obesity.

Application of a roughness-length representation to parameterize energy loss in 3-D numerical simulations of large rivers

Recent technological advances in remote sensing have enabled investigation of the morphodynamics and hydrodynamics of large rivers. However, measuring topography and flow in these very large rivers is time consuming and thus often constrains the spatial resolution and reach-length scales that can be monitored. Similar constraints exist for computational fluid dynamics (CFD) studies of large rivers, requiring maximization of mesh-or grid-cell dimensions and implying a reduction in the representation of bedform-roughness elements that are of the order of a model grid cell or less, even if they are represented in available topographic data. These ``subgrid'' elements must be parameterized, and this paper applies and considers the impact of roughness-length treatments that include the effect of bed roughness due to ``unmeasured'' topography. CFD predictions were found to be sensitive to the roughness-length specification. Model optimization was based on acoustic Doppler current profiler measurements and estimates of the water surface slope for a variety of roughness lengths. This proved difficult as the metrics used to assess optimal model performance diverged due to the effects of large bedforms that are not well parameterized in roughness-length treatments. However, the general spatial flow patterns are effectively predicted by the model. Changes in roughness length were shown to have a major impact upon flow routing at the channel scale. The results also indicate an absence of secondary flow circulation cells in the reached studied, and suggest simpler two-dimensional models may have great utility in the investigation of flow within large rivers. Citation: Sandbach, S. D. et al. (2012), Application of a roughness-length representation to parameterize energy loss in 3-D numerical simulations of large rivers, Water Resour. Res., 48, W12501, doi: 10.1029/2011WR011284.

Homer1a is a core brain molecular correlate of sleep loss.

Sleep is regulated by a homeostatic process that determines its need and by a circadian process that determines its timing. By using sleep deprivation and transcriptome profiling in inbred mouse strains, we show that genetic background affects susceptibility to sleep loss at the transcriptional level in a tissue-dependent manner. In the brain, Homer1a expression best reflects the response to sleep loss. Time-course gene expression analysis suggests that 2,032 brain transcripts are under circadian control. However, only 391 remain rhythmic when mice are sleep-deprived at four time points around the clock, suggesting that most diurnal changes in gene transcription are, in fact, sleep-wake-dependent. By generating a transgenic mouse line, we show that in Homer1-expressing cells specifically, apart from Homer1a, three other activity-induced genes (Ptgs2, Jph3, and Nptx2) are overexpressed after sleep loss. All four genes play a role in recovery from glutamate-induced neuronal hyperactivity. The consistent activation of Homer1a suggests a role for sleep in intracellular calcium homeostasis for protecting and recovering from the neuronal activation imposed by wakefulness.