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.

Angiotensin II favors progression to heart failure in diabetic hearts: role of myocardial fatty acid oxidation downregulation

Purpose: Diabetic myocardium is particularly vulnerable to develop heart failure in response to chronic stress conditions including hypertension or myocardial infarction. We have recently observed that angiotensin II (Ang II)-mediated downregulation of the fatty acid oxidation pathway favors occurrence of heart failure by myocardial accumulation of lipids (lipotoxicity). Because diabetic heart is exposed to high levels of circulating fatty acid, we determined whether insulin resistance favors development of heart failure in mice with Ang II-mediated myocardial remodeling.Methods: To study the combined effect of diabetes and Ang II-induced heart remodeling, we generated leptin-deficient/insulin resistant (Lepob/ob) mice with cardiac targeted overexpression of angiotensinogen (TGAOGN). Left ventricular (LV) failure was indicated by pulmonary congestion (lung weight/tibial length>+2SD of wild-type mice). Myocardial metabolism and function were assessed during in vitro isolated working heart perfusion.Results: Forty-eight percent of TGAOGN mice without insulin resistance exhibited pulmonary congestion at the age of 6 months associated with increased myocardial BNP expression (+375% compared with WT) and reduced LV power (developed pressure x cardiac output; -15%). The proportion of mice presenting heart failure was markedly increased to 71% in TGAOGN mice with insulin resistance (TGAOGN/Lepob/ob). TGAOGN/Lepob/ob mice with heart failure exhibited further increase of BNP compared with failing non-diabetic TGAOGN mice (+146%) and further reduction of cardiac power (-59%). Mice with insulin resistance alone (Lepob/ob) did not exhibit signs of heart failure or LV dysfunction. Myocardial fatty acid oxidation measured during in vitro perfusion was markedly increased in non-failing hearts from Lepob/ob mice (+380% compared with WT) and glucose oxidation decreased (-72%). In contrast, fatty acid and glucose oxidation did not differ from Lepob/ob mice in hearts from TGAOGN/Lepob/ob mice without heart failure. However, both fatty acid and glucose oxidation were markedly decreased (-47% and -48%, respectively, compared with WT/Lepob/+) in failing hearts from TGAOGN/Lepob/ob mice. Reduction of fatty acid oxidation was associated with marked reduction of protein expression of a number of regulatory enzymes implied in fatty acid oxidation.Conclusions: Insulin resistance favors the progression to heart failure during chronic exposure of the myocardium to Ang II. Our results are compatible with a role of Ang II-mediated downregulation of fatty acid oxidation, potentially promoting lipotoxicity.

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.

Differential peptide binding to CD40 evokes counteractive responses.

The antigen-presenting cell-expressed CD40 is implied in the regulation of counteractive immune responses such as induction of pro-inflammatory and anti-inflammatory cytokines interleukin (IL)-12 and IL-10, respectively. The mechanism of this duality in CD40 function remains unknown. Here, we investigated whether such duality depends on ligand binding. Based on CD40 binding, we identifed two dodecameric peptides, peptide-7 and peptide-19, from the phage peptide library. Peptide-7 induces IL-10 and increases Leishmania donovani infection in macrophages, whereas peptide-19 induces IL-12 and reduces L. donovani infection. CD40-peptide interaction analyses by surface plasmon resonance and atomic force microscopy suggest that the functional differences are not associated with the studied interaction parameters. The molecular dynamic simulation of the CD40-peptides interaction suggests that these two peptides bind to two different places on CD40. Thus, we suggest for the first time that differential binding of the ligands imparts functional duality to CD40.

Integration of olfactory information in a spatial representation enabling accurate arm choice in the radial arm maze

The aim of the present study was to determine whether and how rats can use local olfactory cues for spatial orientation. Rats were trained in an eight-arm radial maze under different conditions as defined by the presence or absence of supplementary olfactory cues marking each arm, the availability of distant visuospatial information, and the illumination of the maze (light or darkness). The different visual conditions were designed to dissociate among the effects of light per se and those of visuospatial cues, on the use of olfactory cues for accurate arm choice. Different procedures with modifications of the arrangement of olfactory cues were used to determine if rats formed a representation of the spatial configuration of the olfactory cues and if they could rely on such a representation for accurate arm choice in the radial maze. The present study demonstrated that the use of olfactory cues to direct arm choice in the radial arm maze was critically dependent on the illumination conditions and implied two different modes of processing of olfactory information according to the presence or the absence of light. Olfactory cues were used in an explicit manner and enabled accurate arm choice only in the absence of light. Rats, however, had an implicit memory of the location of the olfactory cues and formed a representation of the spatial position of these cues, whatever the lighting conditions. They did not memorize the spatial configuration of the olfactory cues per se but needed these cues to be linked to the external spatial frame of reference.

Characterization of volatile organic gunshot residues in fired handgun cartridges by headspace sorptive extraction

In forensic investigation of firearm-related cases, determination of the residual amount of volatile compounds remaining inside a cartridge could be useful in estimating the time since its discharge. Published approaches are based on following the decrease of selected target compounds as a function of time by using solid phase micro-extraction (SPME). Naphthalene, as well as an unidentified decomposition product of nitrocellulose (referred to as "TEA2"), are usually employed for this purpose. However, reliability can be brought into question given their high volatility and the low reproducibility of their extracted quantities. In order to identify alternatives and therefore develop improved dating methods, an extensive study on the composition and variability of volatile residues in nine different types of cartridges was carried out. Analysis was performed using headspace sorptive extraction (HSSE), which is a more exhaustive technique compared to SPME. 166 compounds were identified (several of which for the first time), and it was observed that the final compositional characteristics of each residue were strongly dependent on its source. Variability of single identified compounds within and between different types of cartridge, as well as their evolution over time, was also studied. Many explosion products containing up to 4 aromatic rings were found to be globally present in high proportions amongst residues. 27 of them (excluding naphthalene) also presented detectable decreases during the first 24 h. Therefore, they could be used as complementary target analytes in future dating methods.