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.

Alcohol consumption in late adolescence and early adulthood - where is the problem?

Risky single-occasion drinking (RSOD) is more common in late adolescence and early adulthood (approximately between the ages of 16 and 30) than in any other period in life. This is also the age when young people in Switzerland and many other European countries are legally allowed to buy and drink alcohol, but they usually do not yet have adult responsibilities. This paper reviews evidence from the international literature and provides examples of studies conducted in Switzerland demonstrating that (a) RSOD is by far most prevalent on Saturday evenings followed by Friday evenings, usually because young people go out and do not have any work or study responsibilities the next day; (b) RSOD results from drinking in private before going out ("predrinking") and accelerating the pace of drinking (i.e. increasing the number of drinks consumed per hour); (c) RSOD is often not accidental but purposeful,. to seek excitement, to have fun and to feel the effects of alcohol; (d) RSOD occurs predominantly outside the home, mostly in bars, pubs, discos or at special events and festivals; (e) RSOD often results in intended and unintended injuries and other acute consequences, which are leading risk factors for mortality and morbidity in this age group. Effective prevention strategies should include attempts to reduce opportunities to engage in heavy drinking as well as strategies to reduce its harmful consequences.