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.

An alteration in the levels of populations of CD4+ Treg is in part responsible for altered cytokine production by cells of aged mice which follows injection with a fetal liver extract.

We have shown previously that a fetal sheep liver extract (FSLE) containing significant quantities of fetal ovine gamma globin chain (Hbgamma) and LPS injected into aged (>20 months) mice could reverse the altered polarization (increased IL-4 and IL-10 with decreased IL-2 and IFNgamma) in cytokine production seen from ConA stimulated lymphoid cells of those mice. The mechanism(s) behind this change in cytokine production were not previously investigated. We report below that aged mice show a >60% decline in numbers and suppressive function of both CD4(+)CD25(+)Foxp3(+) Treg and so-called Tr3 (CD4(+)TGFbeta(+)), and that their number/function is restored to levels seen in control (8-week-old) mice by FSLE. In addition, on a per cell basis, CD4(+)CD25(-)Treg from aged mice were >4-fold more effective in suppression of proliferation and IL-2 production from ConA-activated lymphoid cells of a pool of CD4(+)CD25(-)T cells from 8-week-old mice than similar cells from young animals, and this suppression by CD25(-)T cells was also ameliorated following FSLE treatment. Infusion of anti-TGFbeta and anti-IL-10 antibodies in vivo altered Treg development following FSLE treatment, and attenuated FSLE-induced alterations in cytokine production profiles.

Temperature-induced sex reversal is not responsible for sex-ratio distortions in grayling Thymallus thymallus or brown trout Salmo trutta.

On the basis of the experiments carried out over various years, it was concluded that (1) grayling Thymallus thymallus and brown trout Salmo trutta are resistant to temperature-induced sex reversal at ecologically relevant temperatures, (2) environmental sex reversal is unlikely to cause the persistent sex ratio distortion observed in at least one of the study populations and (3) sex-specific tolerance of temperature-related stress may be the cause of distorted sex ratios in populations of T. thymallus or S. trutta.