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.

Long-term effects of cannabis on brain structure.

The dose-dependent toxicity of the main psychoactive component of cannabis in brain regions rich in cannabinoid CB1 receptors is well known in animal studies. However, research in humans does not show common findings across studies regarding the brain regions that are affected after long-term exposure to cannabis. In the present study, we investigate (using Voxel-based Morphometry) gray matter changes in a group of regular cannabis smokers in comparison with a group of occasional smokers matched by the years of cannabis use. We provide evidence that regular cannabis use is associated with gray matter volume reduction in the medial temporal cortex, temporal pole, parahippocampal gyrus, insula, and orbitofrontal cortex; these regions are rich in cannabinoid CB1 receptors and functionally associated with motivational, emotional, and affective processing. Furthermore, these changes correlate with the frequency of cannabis use in the 3 months before inclusion in the study. The age of onset of drug use also influences the magnitude of these changes. Significant gray matter volume reduction could result either from heavy consumption unrelated to the age of onset or instead from recreational cannabis use initiated at an adolescent age. In contrast, the larger gray matter volume detected in the cerebellum of regular smokers without any correlation with the monthly consumption of cannabis may be related to developmental (ontogenic) processes that occur in adolescence.

Comparing Multilevel Clustering Methods on Weighted Graphs : The Case of Worldwide Air Passenger Traffic 2000-2004

Specific properties emerge from the structure of large networks, such as that of worldwide air traffic, including a highly hierarchical node structure and multi-level small world sub-groups that strongly influence future dynamics. We have developed clustering methods to understand the form of these structures, to identify structural properties, and to evaluate the effects of these properties. Graph clustering methods are often constructed from different components: a metric, a clustering index, and a modularity measure to assess the quality of a clustering method. To understand the impact of each of these components on the clustering method, we explore and compare different combinations. These different combinations are used to compare multilevel clustering methods to delineate the effects of geographical distance, hubs, network densities, and bridges on worldwide air passenger traffic. The ultimate goal of this methodological research is to demonstrate evidence of combined effects in the development of an air traffic network. In fact, the network can be divided into different levels of âeurooecohesionâeuro, which can be qualified and measured by comparative studies (Newman, 2002; Guimera et al., 2005; Sales-Pardo et al., 2007).

Quality assurance in road traffic analyses in Switzerland.

Swiss laboratories performing toxicological road traffic analyses have been authorized for many years by the Swiss Federal Roads Office (FEDRO). In 2003 FEDRO signed a contract with the Swiss Society of Legal Medicine (SSLM) to organize the complete quality management concerning road traffic analyses. For this purpose a multidisciplinary working group was established under the name of "road traffic commission (RTC)". RTC has to organize external quality control, to interpret the results of these controls, to perform audits in the laboratories and to report all results to FEDRO. Furthermore the working group can be mandated for special tasks by FEDRO. As an independent organization the Swiss Center for Quality Control (CSCQ) in Geneva manages the external quality controls in the laboratory over the past years. All tested drugs and psychoactive substances are listed in a federal instruction. The so-called 'zero tolerance substances' (THC, morphine, cocaine, amphetamine, methamphetamine, MDMA and MDEA) and their metabolites have to be tested once a year, all other substances (benzodiazepines, zolpidem, phenobarbital, etc.) periodically. Results over the last years show that all laboratories are generally within the confidence interval of +/-30% of the mean value. In cases of non-conformities measures have to be taken immediately and reported to the working group. External audits are performed triennially but accredited laboratories can combine this audit with the approval of the Swiss Accreditation Service (SAS). During the audits a special checklist filled in by the laboratory director is assessed. Non-conformities have to be corrected. During the process of establishing a new legislation, RTC had an opportunity of advising FEDRO. In collaboration with FEDRO, RTC and hence SSLM can work actively on improving of quality assurance in road traffic toxicological analyses, and has an opportunity to bring its professional requests to the federal authorities.