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This work contributes to the methodology of valuation of financial derivative contracts in an incomplete market. It focuses on a special type of incompleteness caused by the presence of a non-traded stochastic risk factor, affecting the value of the contract. The non-traded risk factor may only appear in the payoff of the contract or, in addition, may enter the dynamics of the traded asset. We consider both cases. We suggest a discrete time discrete space binomial model for the traded stock and the non-traded risk factor. We work in the utility maximization framework with dynamically changing agent's preferences. We present a discrete time multi-period analog of the forward and backward utility processes recently developed in continuous time. We use methods of stochastic control and provide the indifference valuation algorithm with both the forward and backward dynamic utilities. We compare the two approaches and provide conditions under which they assign the same value to the contract. We show that unlike the backward dynamic utility, the forward dynamic utility yields prices that do not depend on the end of the investment horizon. We pay attention to the choice of the equivalent martingale measure used for valuation (i.e., the minimal martingale measure and the minimal entropy measure for the forward and the backward utility processes correspondingly). We explicitly characterize both measures and give conditions under which they coincide. We extend our algorithm to the case of American and partial exercise contracts. We illustrate our work with numerical examples, showing that in an incomplete market, a call option on a non-traded risk factor may optimally be exercised early, and that it may be optimal to exercise only a fraction of the total number of contracts held, if partial exercise is allowed. In continuous time we extend the existing results to the case of American contracts with both the backward and the forward utilities. We emphasize the similarities between our discrete time valuation algorithm and the continuous time valuation. The two approaches use the same pricing measures, yield prices through nonlinear functionals of similar form, exhibit a similar relationship between the backward and forward prices, and a similar structure for the aggregate minimal entropy. We believe that our work makes a contribution by exposing the two above mentioned ways of dependence on the non-traded risk factor, and by providing a new dynamic indifference pricing algorithm that allows consistent valuation across different investment horizons.

In recent years, several new theories have been developedrelating the value of the firm to its capital structure, or explainingwhy firms issue debt securities. However, empirical testing ofthe varying predictions of these theories has not kept pace. Moreover,most investigations have been done on regulated utilities because ofalleged risk homogeneity. The results are ambiguous and cannot begeneralized due to regulatory treatment of taxes.The present investigation is carried out on a broad crosssectionof industrial firms and takes explicit account of businessrisk variations as well as dealing with other econometric problemsignored in previous studies. The results are consistent with Miller's(1977) hypothesis that the value of the firm is independent of leveragein the absence of bankruptcy costs. However, the results are alsoconsistent with the existence of significant leverage-related costswhich vary directly with business risk. / L'etude de l1incidence du levier financier d'une firme sur sa valeurde marche ainsi que des. differentes raisons pour lesquelles une firmeferait appel au marche des obligations pour assurer son financement asuscite ces dernieres annees le developpement de nouvelles approchestheoriques du probleme. Le travail de verification empirique, toutefois,n'a guere suivi et, en particulier, seules les compagnies etroitementsoumises au controle gouvernemental ont fait l'objet d'une etudeapprofondie, du fait sans doute de leur appartenance presumee a lameme classe de risque et ce, en depit du traitement fiscal particulierdont beneficient ces compagnies. De ce fait, les resultats empiriquesactuellement disponibles ne sont pas depourvus d'ambiguite et ne sauraientetre generalises.[...]

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Standard finance theory portrays investors as rational utility maximisers. Persisting market anomalies and observed investor practice, however, have led to widespread recognition that the fundamental axioms of rationality are often violated. In response to the limitations inherent in standard theory, the Behavioural Finance approach relaxes the rationality assumption and takes account of psychological influences on individuals’ decision-making processes. Adopting the behavioural approach, this thesis, which includes two empirical studies, examines why, and to what extent, investors depart from rational or optimal investment practices. The thesis examines the effect of Myopic Loss Aversion (MLA) suggested by Benartzi and Thaler (1995) as a response to the Equity Premium Puzzle highlighted by Mehra and Prescott (1985). While previous studies are almost exclusively based on experiments in a laboratory setting, this approach provides more compelling empirical evidence by investigating the effects of MLA on real individual investors’ portfolio allocations through the use of the Dutch National Bank Household Survey. For the first time, the concept of MLA is identified through the interaction of two separate effects, firstly, individuals’ myopia, reflected in portfolio evaluation and rebalancing frequencies, and secondly, loss aversion. The thesis finds that individuals who are less affected by MLA invest more in risky financial assets. Further, individuals who are less myopic increase their share of risky assets invested in their financial portfolios over time, although this is unrelated to their loss aversion. These findings support the prediction of MLA theory that short investment horizons and high loss aversion lead to a significantly lower share of risky investments. In summary, the high equity premium can be explained by the notion of MLA. If individuals evaluate their investment performance over the long-term, they perceive much smaller risks relative to stockholding returns; consequently, they will be prepared to accept smaller equity premiums. The findings suggest possible interventions by policy makers and investment advisors to encourage individuals to remain in the stock market, such as providing long-term investment instruments, or restricting evaluation frequency to the annual reporting of investment performance. In response to the stockholding puzzle (Haliassos and Bertaut, 1995), this thesis also investigates individuals’ stock market returns expectations and their varying levels of risk aversion. Previous studies find that individuals’ heterogeneous stock market expectations determine variations in their stockholdings. The thesis accounts for the effect of risk aversion on stock market expectations, as well as on stockholding decisions. Additionally, the causality issue as between individuals’ expectations and stockholding status is controlled. The thesis finds that more risk averse individuals hold lower stock market expectations, and that the stock market return expectations of more risk averse individuals affect their stock market participation decisions negatively. The portfolio allocation decisions of individuals who already hold stocks are only affected by their expectations, with risk aversion being no longer significant. The thesis argues that persistent risk aversion effects cause individuals to hold pessimistic views of stock market returns, thus contributing to the enduring stockholding puzzle. The thesis reinforces existing perceptions that individuals in the real world may not make fully rational decisions due to their judgments which are based on heuristics and affected by cognitive biases. Individual investors often fail to maximise their utility given their preferences and constraints. Consequently, this thesis draws attention to the possible role of institutions, policy makers, and financial advisory bodies in providing effective interventions and guidelines to improve individuals’ financial decisions.

In this thesis, the seat inventory control problem is studied for airlines from the perspective of a risk-averse decision maker. There are only a few studies in the revenue management literature that consider the risk factor. Most of the studies aim at finding the optimal seat allocations while maximizing the expected revenue and do not take the variability of the revenue and hence a risk measure into account. This study aims to decrease the variance of the revenue by increasing the capacity utilization called load factor in the revenue management literature. In addition to expected revenue, load factor is an important performance measure the state companies work with. For this purpose, two types of models with load factor formulations are proposed. This thesis is the first study in the revenue management literature for the airline industry that uses the load factor formulations in the mathematical models. It is an advantage to work with load factor formulations since the models with load factor formulations are much easier to formulate and solve as compared to other risk sensitive models in the literature. The results of the proposed models are evaluated by using simulation for a sample network under different scenarios. The models we propose allow us to control the variability of revenue by changing the used capacity of the aircraft. This is at the expense of a decrease in the revenue under some scenarios. The models we propose perform satisfactorily under all scenarios and they are strongly recommended to be used especially for the small-scale airline companies and state companies and for scheduling new flights even in large scale, well established airline companies.

In this thesis we consider two comparative statics questions of changes in risk. The first question concerns situations where an individual faces some risk and has no control over the uncertain environment. In these situations we ask what kind of changes in risk will cause the individual's expected utility to increase. The second comparative statics question concerns situations where an individual faces some risk and has some control over the uncertain environment. In particular, we consider situations where the individual maximizes her expected utility with respect to some control parameter. Here we ask what kind of changes in risk will cause the individual's optimal value of the control parameter to increase. The existing literature has answered these questions for a class of individuals (for example, the class of risk averse individuals). This thesis differs from existing literature as it focuses on a given individual, and thus reveals some of the person-specific factors that affect individual?s responses to changes in risk. The aim of the thesis is to show how an order on distributions, termed single crossing likelihood ratio (SCLR) order, can intuitively answer both questions for a given individual. The main contributions of the thesis are as follows. First, the thesis presents the SCLR order and its main properties. Second, the thesis shows that the SCLR order can answer the above comparative statics questions in an intuitive way. In particular, the thesis shows that the answer to the above questions, with the use of the SCLR order, depends on a risk reference point which can be interpreted as a "certainty equivalent" point. Thus it is demonstrated that individual's responses to changes in risk are affected by her "certainty equivalent" point. Lastly, the results of the thesis can be used to provide an intuitive explanation of related existing results that were obtained for a class of individuals.

In this thesis we consider two comparative statics questions of changes in risk. The first question concerns situations where an individual faces some risk and has no control over the uncertain environment. In these situations we ask what kind of changes in risk will cause the individual's expected utility to increase. The second comparative statics question concerns situations where an individual faces some risk and has some control over the uncertain environment. In particular, we consider situations where the individual maximizes her expected utility with respect to some control parameter. Here we ask what kind of changes in risk will cause the individual's optimal value of the control parameter to increase. The existing literature has answered these questions for a class of individuals (for example, the class of risk averse individuals). This thesis differs from existing literature as it focuses on a given individual, and thus reveals some of the person-specific factors that affect individual?s responses to changes in risk. The aim of the thesis is to show how an order on distributions, termed single crossing likelihood ratio (SCLR) order, can intuitively answer both questions for a given individual. The main contributions of the thesis are as follows. First, the thesis presents the SCLR order and its main properties. Second, the thesis shows that the SCLR order can answer the above comparative statics questions in an intuitive way. In particular, the thesis shows that the answer to the above questions, with the use of the SCLR order, depends on a risk reference point which can be interpreted as a "certainty equivalent" point. Thus it is demonstrated that individual's responses to changes in risk are affected by her "certainty equivalent" point. Lastly, the results of the thesis can be used to provide an intuitive explanation of related existing results that were obtained for a class of individuals.