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.

Comprehensive Statewide Transportation Model: Multimodal Investment Analysis Methodology Phase II, CTRE Project 02-126, 2001

The purposes of this report (Phase II of the project) are to specify in mathematical form the individual modules of the conceptual model developed in Phase I, to identify and evaluate sources of data for the model set, and to develop the transport networks necessary to support the models.

A Legislator under Surveillance: The Creation and Implementation of Swiss Banking Legislation 1910-1934

This paper analyses how banking regulation was introduced in Switzerland - one of the world's most prominent financial centres - which remained in place until the beginning of the twenty-first century. It shows that the law adopted on 8 November 1934 is a perfect example of capture of the regulator by the regulated. Essentially a political response in the context of the economic crisis of the 1930s, it largely reflected the interests of banking circles by limiting the intervention of the State as much as possible. The introduction of the new legislation was facilitated by the temporary weakness of Swiss banking circles, as they depended on the State to delay or prevent the collapse of many major credit institutions. They did not manage to derail the law as they had two decades earlier when they scuppered the federal bill on banks drawn up between 1914 and 1916. But this time they were better organized and more united, and intervened all the more effectively in the legislative process itself. The 1934 law is thus distinctive in that it made no structural changes to the architecture of the financial centre but merely codified its practices through flexible legislation meant to reassure the public. The law was aimed less at controlling banking activity than at keeping - thanks to skilfully calibrated political concessions - the State from having to intervene more directly in the internal management of banks or in the fixing of interest rates and the export of capital.

Feeding rates, parental investment, and brood reduction in Caspian terns (Sterna caspia)

Fresh egg-weights and feeding rates to chicks were related to chick survival as one means of quantifying apportionment of parental investment wi thin broods of Caspian Terns (SterDI casRla) at a colony in Georgian Bay. Lake Huron, during 1978 and 1979. Ftrst-laid eggs from 2-egg clutches were Significantly heavier and usually hatched one to three days earlier than second-laid eggs in both years of the study. In both years, first-hatched chicks were larger and generally better fed than second-hatched siblings. The disparity between feedIng rates of first- and second-hatched ehicks was greater in 1979. Brood feeding I rates correlated positively with the percentage of food fed to the least-fed sibUng through the period of B-chick ages zero to 10 days in 1978. I suggest that after this age period, parental control over whlcb cbick was fed diminished. In 1978, 10 of 16 secondhatched chicks were fed more than their older siblings during their first 5 days. 'lb.is is interpreted as a parental response to reduce the competitive advantage of the larger first-hatched chicks. Most chick losses were apparently caused by starvation or preda. tion. In 1979, seeorvl-hatched chick disappearance (due to predation) was -related to low feeding rates, whereas first-hatched chick disappearance was related to low fresh egg-weights.. First-hatched chicks survived better than second-hatched chicks both years, and more pairs fledged two chicks in 1978. Maximum estimated feeding rates at the nest and fledging ages suggested that food was more avatlable in 1978 than in 1979. In 1979, second eggs apparently functioned as "insurance" eggs. When the first-laid egg falled to hatch, or the first-hatched chick died, the second-hatched chick was often successfully fledged. When first-hatched chicks survived, the second-hatched chick usually starved or was preyed upon, reducing the brood to one chick. Parental investment patterns favored first-hatched chicks. Brood reduction, when employed, discouraged total nest failure, however, under appropriate conditions, brood reduction was avoided and full broods (or two chicks) were fledged.

DNA Banking: current and ideal practices

Ce livre est la conclusion d’un projet de recherche de deux ans portant sur les technologies en génétique humaine. Les développements récents en matière de collecte, d’analyse et de conservation du matériel génétique ont soulevé des questions juridiques complexes et ont attiré l’attention de plusieurs avocats, scientifiques et du public. Ce livre présente une analyse de ces questions et une comparaison de la position et de la politique canadienne avec celle en émergence dans divers pays

Trade Creation, Trade Diversion and Investment Flows: Evidence from the Canada-Chile Free Trade Agreement.

Rapport de recherche

The role of investment specific technological shocks in explaining macroeconomics fluctuations.

Rapport de recherche

Investment Under Demand Uncertainty: the Newsboy Problem Revisited.

In this article we study the effect of uncertainty on an entrepreneur who must choose the capacity of his business before knowing the demand for his product. The unit profit of operation is known with certainty but there is no flexibility in our one-period framework. We show how the introduction of global uncertainty reduces the investment of the risk neutral entrepreneur and, even more, that the risk averse one. We also show how marginal increases in risk reduce the optimal capacity of both the risk neutral and the risk averse entrepreneur, without any restriction on the concave utility function and with limited restrictions on the definition of a mean preserving spread. These general results are explained by the fact that the newsboy has a piecewise-linear, and concave, monetary payoff witha kink endogenously determined at the level of optimal capacity. Our results are compared with those in the two literatures on price uncertainty and demand uncertainty, and particularly, with the recent contributions of Eeckhoudt, Gollier and Schlesinger (1991, 1995).

Rigidité normale, dévaluation et équilibre général intertemporel

La présente étude analyse les effets dynamiques de la dévaluation du franc CFA, à l’aide d’un modèle monétaire d’équilibre général, intertemporel et multisectoriel. L’accent est particulièrement mis sur les interactions entre dévaluation et accumulation du capital. Dans le modèle, les effets du changement de parité passent par le marché du travail qui se caractérise par l’inertie du salaire nominal. Les résultats montrent que la dévaluation relance l’investissement, avec des effets expansionnistes sur l’activité économique. Le choc monétaire n’a eu qu’un impact limité sur les soldes budgétaire et commercial. Une mesure d’accompagnement telle que la réduction des salaires de la fonction publique améliore ces deux soldes mais déclenche un processus récessif.

The Transmission of Monetary Policy in a Multi-Sector Economy

This paper constructs and estimates a sticky-price, Dynamic Stochastic General Equilibrium model with heterogenous production sectors. Sectors differ in price stickiness, capital-adjustment costs and production technology, and use output from each other as material and investment inputs following an Input-Output Matrix and Capital Flow Table that represent the U.S. economy. By relaxing the standard assumption of symmetry, this model allows different sectoral dynamics in response to monetary policy shocks. The model is estimated by Simulated Method of Moments using sectoral and aggregate U.S. time series. Results indicate 1) substantial heterogeneity in price stickiness across sectors, with quantitatively larger differences between services and goods than previously found in micro studies that focus on final goods alone, 2) a strong sensitivity to monetary policy shocks on the part of construction and durable manufacturing, and 3) similar quantitative predictions at the aggregate level by the multi-sector model and a standard model that assumes symmetry across sectors.

The euro impact of the banking system of Greece : cost-benefit analysis.

Rapport de recherche

Investment Under Demand Uncertainty: the Newsboy Problem Revisited.

In this article we study the effect of uncertainty on an entrepreneur who must choose the capacity of his business before knowing the demand for his product. The unit profit of operation is known with certainty but there is no flexibility in our one-period framework. We show how the introduction of global uncertainty reduces the investment of the risk neutral entrepreneur and, even more, that the risk averse one. We also show how marginal increases in risk reduce the optimal capacity of both the risk neutral and the risk averse entrepreneur, without any restriction on the concave utility function and with limited restrictions on the definition of a mean preserving spread. These general results are explained by the fact that the newsboy has a piecewise-linear, and concave, monetary payoff witha kink endogenously determined at the level of optimal capacity. Our results are compared with those in the two literatures on price uncertainty and demand uncertainty, and particularly, with the recent contributions of Eeckhoudt, Gollier and Schlesinger (1991, 1995).