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.

Device-specific weighted T-score for two quantitative ultrasounds: operational propositions for the management of osteoporosis for 65 years and older women in Switzerland.

The World Health Organization (WHO) criteria for the diagnosis of osteoporosis are mainly applicable for dual X-ray absorptiometry (DXA) measurements at the spine and hip levels. There is a growing demand for cheaper devices, free of ionizing radiation such as promising quantitative ultrasound (QUS). In common with many other countries, QUS measurements are increasingly used in Switzerland without adequate clinical guidelines. The T-score approach developed for DXA cannot be applied to QUS, although well-conducted prospective studies have shown that ultrasound could be a valuable predictor of fracture risk. As a consequence, an expert committee named the Swiss Quality Assurance Project (SQAP, for which the main mission is the establishment of quality assurance procedures for DXA and QUS in Switzerland) was mandated by the Swiss Association Against Osteoporosis (ASCO) in 2000 to propose operational clinical recommendations for the use of QUS in the management of osteoporosis for two QUS devices sold in Switzerland. Device-specific weighted "T-score" based on the risk of osteoporotic hip fractures as well as on the prediction of DXA osteoporosis at the hip, according to the WHO definition of osteoporosis, were calculated for the Achilles (Lunar, General Electric, Madison, Wis.) and Sahara (Hologic, Waltham, Mass.) ultrasound devices. Several studies (totaling a few thousand subjects) were used to calculate age-adjusted odd ratios (OR) and area under the receiver operating curve (AUC) for the prediction of osteoporotic fracture (taking into account a weighting score depending on the design of the study involved in the calculation). The ORs were 2.4 (1.9-3.2) and AUC 0.72 (0.66-0.77), respectively, for the Achilles, and 2.3 (1.7-3.1) and 0.75 (0.68-0.82), respectively, for the Sahara device. To translate risk estimates into thresholds for clinical application, 90% sensitivity was used to define low fracture and low osteoporosis risk, and a specificity of 80% was used to define subjects as being at high risk of fracture or having osteoporosis at the hip. From the combination of the fracture model with the hip DXA osteoporotic model, we found a T-score threshold of -1.2 and -2.5 for the stiffness (Achilles) determining, respectively, the low- and high-risk subjects. Similarly, we found a T-score at -1.0 and -2.2 for the QUI index (Sahara). Then a screening strategy combining QUS, DXA, and clinical factors for the identification of women needing treatment was proposed. The application of this approach will help to minimize the inappropriate use of QUS from which the whole field currently suffers.

Metabolically healthy obesity: different prevalences using different criteria.

To estimate the prevalence of metabolically healthy obesity (MHO) according to different definitions. Population-based sample of 2803 women and 2557 men participated in the study. Metabolic abnormalities were defined using six sets of criteria, which included different combinations of the following: waist; blood pressure; total, high-density lipoprotein or low-density lipoprotein-cholesterol; triglycerides; fasting glucose; homeostasis model assessment; high-sensitivity C-reactive protein; personal history of cardiovascular, respiratory or metabolic diseases. For each set, prevalence of MHO was assessed for body mass index (BMI); waist or percent body fat. Among obese (BMI 30 kg/m(2)) participants, prevalence of MHO ranged between 3.3 and 32.1% in men and between 11.4 and 43.3% in women according to the criteria used. Using abdominal obesity, prevalence of MHO ranged between 5.7 and 36.7% (men) and 12.2 and 57.5% (women). Using percent body fat led to a prevalence of MHO ranging between 6.4 and 43.1% (men) and 12.0 and 55.5% (women). MHO participants had a lower odd of presenting a family history of type 2 diabetes. After multivariate adjustment, the odds of presenting with MHO decreased with increasing age, whereas no relationship was found with gender, alcohol consumption or tobacco smoking using most sets of criteria. Physical activity was positively related, whereas increased waist was negatively related with BMI-defined MHO. MHO prevalence varies considerably according to the criteria used, underscoring the need for a standard definition of this metabolic entity. Physical activity increases the likelihood of presenting with MHO, and MHO is associated with a lower prevalence of family history of type 2 diabetes.