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.

Conjunctival MALT lymphoma: utility of FDG PET/CT for diagnosis, staging, and evaluation of treatment response.

A 67-year-old woman was referred for staging of a mucosa-associated lymphoid tumor lymphoma involving the left conjunctiva. CT scan had shown paravertebral and pelvic masses, and a breast nodule. FDG PET/CT demonstrated moderately increased uptake in the left ocular conjunctiva and confirmed the paravertebral and pelvic masses and the breast nodule. Moreover, abnormal FDG uptake was shown in 2 breast nodules, the flank, the gluteus maximus, and the gastric cardia. The patient received 6 cycles of rituximab-bendamustine chemotherapy with a complete clinical and metabolic response at the 6-month follow-up PET/CT and remained relapse-free without visual acuity problem after a 36-month follow-up.

Notch1 and T-cell development: insights from conditional knockout mice.

Notch proteins influence cell-fate decisions in many developmental systems. Gain-of-function studies have suggested a crucial role for Notch1 signaling at several stages during lymphocyte development, including the B/T, alphabeta/gammadelta and CD4/CD8 lineage choices. Here, we critically re-evaluate these conclusions in the light of recent studies that describe inducible and tissue-specific targeting of the Notch1 gene.

Optimal dividend strategies for a compound Poisson risk process under transaction costs and power utility

We characterize the value function of maximizing the total discounted utility of dividend payments for a compound Poisson insurance risk model when strictly positive transaction costs are included, leading to an impulse control problem. We illustrate that well known simple strategies can be optimal in the case of exponential claim amounts. Finally we develop a numerical procedure to deal with general claim amount distributions.

The political economy of international regulatory convergence in public utilities

To what extent should public utilities regulation be expected to converge across countries? When it occurs, will it generate good outcomes? Building on the core proposition of the New Institutional Economics that similar regulations generate different outcomes depending on their fit with the underlying domestic institutions, we develop a simple model and explore its implications by examining the diffusion of local loop unbundling (LLU) regulations. We argue that: one should expect some convergence in public utility regulation but with still a significant degree of local experimentation; this process will have very different impacts of regulation.