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.

Three essays on bankruptcy risk

Abstract Market prices of corporate bond spreads and of credit default swap (CDS) rates do not match each other. In this paper, we argue that the liquidity premium, the cheapest-to-deliver (CTD) option and actual market segmentation explain the pricing differences. Using the European transaction data from Reuters and Bloomberg, we estimate the liquidity premium that is time- varying and firm-specific. We show that when time-dependent liquidity premiums are considered, corporate bond spreads and CDS rates behave in a much closer way than previous studies have shown. We find that high equity volatility drives pricing differences that can be explained by the CTD option.

Coffee and tea intake and risk of head and neck cancer: pooled analysis in the International Head and Neck Cancer Epidemiology Consortium.

BACKGROUND: Only a few studies have explored the relation between coffee and tea intake and head and neck cancers, with inconsistent results. METHODS: We pooled individual-level data from nine case-control studies of head and neck cancers, including 5,139 cases and 9,028 controls. Logistic regression was used to estimate odds ratios (OR) and 95% confidence intervals (95% CI), adjusting for potential confounders. RESULTS: Caffeinated coffee intake was inversely related with the risk of cancer of the oral cavity and pharynx: the ORs were 0.96 (95% CI, 0.94-0.98) for an increment of 1 cup per day and 0.61 (95% CI, 0.47-0.80) in drinkers of >4 cups per day versus nondrinkers. This latter estimate was consistent for different anatomic sites (OR, 0.46; 95% CI, 0.30-0.71 for oral cavity; OR, 0.58; 95% CI, 0.41-0.82 for oropharynx/hypopharynx; and OR, 0.61; 95% CI, 0.37-1.01 for oral cavity/pharynx not otherwise specified) and across strata of selected covariates. No association of caffeinated coffee drinking was found with laryngeal cancer (OR, 0.96; 95% CI, 0.64-1.45 in drinkers of >4 cups per day versus nondrinkers). Data on decaffeinated coffee were too sparse for detailed analysis, but indicated no increased risk. Tea intake was not associated with head and neck cancer risk (OR, 0.99; 95% CI, 0.89-1.11 for drinkers versus nondrinkers). CONCLUSIONS: This pooled analysis of case-control studies supports the hypothesis of an inverse association between caffeinated coffee drinking and risk of cancer of the oral cavity and pharynx. IMPACT: Given widespread use of coffee and the relatively high incidence and low survival of head and neck cancers, the observed inverse association may have appreciable public health relevance.

DQB1 locus alone explains most of the risk and protection in narcolepsy with cataplexy in Europe.

STUDY OBJECTIVE: Prior research has identified five common genetic variants associated with narcolepsy with cataplexy in Caucasian patients. To replicate and/or extend these findings, we have tested HLA-DQB1, the previously identified 5 variants, and 10 other potential variants in a large European sample of narcolepsy with cataplexy subjects. DESIGN: Retrospective case-control study. SETTING: A recent study showed that over 76% of significant genome-wide association variants lie within DNase I hypersensitive sites (DHSs). From our previous GWAS, we identified 30 single nucleotide polymorphisms (SNPs) with P < 10(-4) mapping to DHSs. Ten SNPs tagging these sites, HLADQB1, and all previously reported SNPs significantly associated with narcolepsy were tested for replication. PATIENTS AND PARTICIPANTS: For GWAS, 1,261 narcolepsy patients and 1,422 HLA-DQB1*06:02-matched controls were included. For HLA study, 1,218 patients and 3,541 controls were included. MEASUREMENTS AND RESULTS: None of the top variants within DHSs were replicated. Out of the five previously reported SNPs, only rs2858884 within the HLA region (P < 2x10(-9)) and rs1154155 within the TRA locus (P < 2x10(-8)) replicated. DQB1 typing confirmed that DQB1*06:02 confers an extraordinary risk (odds ratio 251). Four protective alleles (DQB1*06:03, odds ratio 0.17, DQB1*05:01, odds ratio 0.56, DQB1*06:09 odds ratio 0.21, DQB1*02 odds ratio 0.76) were also identified. CONCLUSION: An overwhelming portion of genetic risk for narcolepsy with cataplexy is found at DQB1 locus. Since DQB1*06:02 positive subjects are at 251-fold increase in risk for narcolepsy, and all recent cases of narcolepsy after H1N1 vaccination are positive for this allele, DQB1 genotyping may be relevant to public health policy.

Systematic evaluation of risk factors for diagnostic delay in inflammatory bowel disease.

The diagnosis of inflammatory bowel disease (IBD), comprising Crohn's disease (CD) and ulcerative colitis (UC), continues to present difficulties due to unspecific symptoms and limited test accuracies. We aimed to determine the diagnostic delay (time from first symptoms to IBD diagnosis) and to identify associated risk factors. A total of 1591 IBD patients (932 CD, 625 UC, 34 indeterminate colitis) from the Swiss IBD cohort study (SIBDCS) were evaluated. The SIBDCS collects data on a large sample of IBD patients from hospitals and private practice across Switzerland through physician and patient questionnaires. The primary outcome measure was diagnostic delay. Diagnostic delay in CD patients was significantly longer compared to UC patients (median 9 versus 4 months, P < 0.001). Seventy-five percent of CD patients were diagnosed within 24 months compared to 12 months for UC and 6 months for IC patients. Multivariate logistic regression identified age <40 years at diagnosis (odds ratio [OR] 2.15, P = 0.010) and ileal disease (OR 1.69, P = 0.025) as independent risk factors for long diagnostic delay in CD (>24 months). In UC patients, nonsteroidal antiinflammatory drug (NSAID intake (OR 1.75, P = 0.093) and male gender (OR 0.59, P = 0.079) were associated with long diagnostic delay (>12 months). Whereas the median delay for diagnosing CD, UC, and IC seems to be acceptable, there exists a long delay in a considerable proportion of CD patients. More public awareness work needs to be done in order to reduce patient and doctor delays in this target population.

Regional differences in self-reported screening, prevalence and management of cardiovascular risk factors in Switzerland.

BACKGROUND: In Switzerland, health policies are decided at the local level, but little is known regarding their impact on the screening and management of cardiovascular risk factors (CVRFs). We thus aimed at assessing geographical levels of CVRFs in Switzerland.¦METHODS: Swiss Health Survey for 2007 (N = 17,879). Seven administrative regions were defined: West (Leman), West-Central (Mittelland), Zurich, South (Ticino), North-West, East and Central Switzerland. Obesity, smoking, hypertension, dyslipidemia and diabetes prevalence, treatment and screening within the last 12 months were assessed by interview.¦RESULTS: After multivariate adjustment for age, gender, educational level, marital status and Swiss citizenship, no significant differences were found between regions regarding prevalence of obesity or current smoking. Similarly, no differences were found regarding hypertension screening and prevalence. Two thirds of subjects who had been told they had high blood pressure were treated, the lowest treatment rates being found in East Switzerland: odds-ratio and [95% confidence interval] 0.65 [0.50-0.85]. Screening for hypercholesterolemia was more frequently reported in French (Leman) and Italian (Ticino) speaking regions. Four out of ten participants who had been told they had high cholesterol levels were treated and the lowest treatment rates were found in German-speaking regions. Screening for diabetes was higher in Ticino (1.24 [1.09 - 1.42]). Six out of ten participants who had been told they had diabetes were treated, the lowest treatment rates were found for German-speaking regions.¦CONCLUSIONS: In Switzerland, cardiovascular risk factor screening and management differ between regions and these differences cannot be accounted for by differences in populations' characteristics. Management of most cardiovascular risk factors could be improved.