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.

Association between white-coat effect and blunted dipping of nocturnal blood pressure.

In this study, we assessed whether the white-coat effect (difference between office and daytime blood pressure (BP)) is associated with nondipping (absence of BP decrease at night). Data were available in 371 individuals of African descent from 74 families selected from a population-based hypertension register in the Seychelles Islands and in 295 Caucasian individuals randomly selected from a population-based study in Switzerland. We used standard multiple linear regression in the Swiss data and generalized estimating equations to account for familial correlations in the Seychelles data. The prevalence of systolic and diastolic nondipping (<10% nocturnal BP decrease) and white-coat hypertension (WCH) was respectively 51, 46, and 4% in blacks and 33, 37, and 7% in whites. When white coat effect and nocturnal dipping were taken as continuous variables (mm Hg), systolic (SBP) and diastolic BP (DBP) dipping were associated inversely and independently with white-coat effect (P < 0.05) in both populations. Analogously, the difference between office and daytime heart rate was inversely associated with the difference between daytime and night-time heart rate in the two populations. These results did not change after adjustment for potential confounders. The white-coat effect is associated with BP nondipping. The similar associations between office-daytime values and daytime-night-time values for both BP and heart rate suggest that the sympathetic nervous system might play a role. Our findings also further stress the interest, for clinicians, of assessing the presence of a white-coat effect as a means to further identify patients at increased cardiovascular risk and guide treatment accordingly.

Social sensing for psychology: Automated interpersonal behavior assessment

In this article, we show how the use of state-of-the-art methods in computer science based on machine perception and learning allows the unobtrusive capture and automated analysis of interpersonal behavior in real time (social sensing). Given the high ecological validity of the behavioral sensing, the ease of behavioral-cue extraction for large groups over long observation periods in the field, the possibility of investigating completely new research questions, and the ability to provide people with immediate feedback on behavior, social sensing will fundamentally impact psychology.