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.

Psychometrics of the Dyadic Coping Inventory in three language groups

This article introduces the Dyadic Coping Inventory (DCI; Bodenmann, 2008) and aims (1) to investigate the reliability and aspects of the validity of the Italian and French versions of the DCI, and (2) to replicate its factor structure and reliabilities using a new Swiss German sample. Based on 216 German-, 378 Italian-, and 198 French-speaking participants, the factor structure of the original German inventory was able to be replicated by using principal components analysis in all three groups after excluding two items in the Italian and French versions. The latter were shown to be as reliable as the German version with the exception of the low reliabilities of negative dyadic coping in the French group. Confirmatory factor analyses provided additional support for delegated dyadic coping and evaluation of dyadic coping. Intercorrelations among scales were similar across all three languages groups with a few exceptions. Previous findings could be replicated in all three groups, showing that aspects of dyadic coping were more strongly related to marital quality than to dyadic communication. The use of the dyadic coping scales in the actor-partner interdependence model, the common fate model, and the mutual influence model is discussed.

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.