Research
Lo, Andrew W., Ruixun Zhang, and Chaoyi Zhao (2022), Measuring and Optimizing the Risk and Reward of Green Portfolios, The Journal of Impact and ESG Investing 3 (2), 55-99.
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We study the performance of green portfolios in both the US and Chinese markets, constructed using a broad range of climate-related environmental metrics, including carbon emissions, water consumption, waste disposal, land and water pollutants, air pollutants, and natural resource use. We compare several popular long-only and long–short green portfolio construction methodologies and find that a method based on Treynor–Black weights offers the most robust performance, thanks to its ability to quantify alphas for individual assets using only a small number of parameters. In the United States, green portfolios (e.g., low-carbon portfolios) have realized positive alphas in excess of Fama–French factors, a significant portion of which can be explained by an unexpected increase in climate concerns over the past decade, rather than positive expected returns. In contrast, Chinese investors have borne a cost for holding green assets instead of brown assets over the past seven years, implying a positive carbon premium, the opposite of US markets.
Lo, Andrew W., Richard Thakor (2022), Financing Biomedical Innovation, Annual Reviews 14, 231-270.
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We review the recent literature on financing biomedical innovation, with a specific focus on the drug development process and how it may be enhanced to improve outcomes. We begin by laying out stylized facts about the structure of the drug development process and its associated costs and risks, and we present evidence that the rate of discovery for life-saving treatments has declined over time while costs have increased. We make the argument that these structural features require drug development (i.e., biopharmaceutical) firms to rely on external financing and at the same time amplify market frictions that may hinder the ability of these firms to obtain financing, especially for treatments that may have large societal value relative to the benefits going to the firms and their investors. We then provide an overview of the evidence for various types of market frictions to which these drug development firms are exposed and discuss how these frictions affect their incentive to invest in the development of new drugs, leading to underinvestment in valuable treatments. In light of this evidence, numerous studies have proposed ways to overcome this funding gap, including the use of financial innovation. We discuss the potential of these approaches to improve outcomes.
The Wisdom of Crowds Versus the Madness of Mobs: An Evolutionary Model of Bias, Polarization, and Other Challenges to Collective Intelligence
Lo, Andrew W., Ruixun Zhang (2022), The Wisdom of Crowds Versus the Madness of Mobs: An Evolutionary Model of Bias, Polarization, and Other Challenges to Collective Intelligence, Collective Intelligence, 1- 22.
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Despite its success in financial markets and other domains, collective intelligence seems to fall short in many critical contexts, including infrequent but repeated financial crises, political polarization and deadlock, and various forms of bias and discrimination. We propose an evolutionary framework that provides fundamental insights into the role of heterogeneity
and feedback loops in contributing to failures of collective intelligence. The framework is based on a binary choice model of behavior that affects fitness; hence, behavior is shaped by evolutionary dynamics and stochastic changes in environmental conditions. We derive collective intelligence as an emergent property of evolution in this framework, and also specify conditions under which it fails. We find that political polarization emerges in stochastic environments with reproductive risks that are correlated across individuals. Bias and discrimination emerge when individuals incorrectly attribute random adverse events to observable features that may have nothing to do with those events. In addition, path dependence and negative feedback in evolution may lead to even stronger biases and levels of discrimination, which are locally evolutionarily
stable strategies. These results suggest potential policy interventions to prevent such failures by nudging the “madness of mobs” towards the “wisdom of crowds” through targeted shifts in the environment
The reaction of sponsor stock prices to clinical trial outcomes: An event study analysis
Singh, Manish, Roland Rocafort, Cathy Cai, Kien Wei Siah, Andrew W. Lo (2022), The reaction of sponsor stock prices to clinical trial outcomes: An event study analysis, PLoS ONE 17(9).
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We perform an event study analysis that quantifies the market reaction to clinical trial result announcements for 13,807 trials from 2000 to 2020, one of the largest event studies of clinical trials to date. We first determine the specific dates in the clinical trial process on which the greatest impact on the stock prices of their sponsor companies occur. We then analyze the relationship between the abnormal returns observed on these dates due to the clinical trial outcome and the properties of the trial, such as its phase, target accrual, design category, and disease and sponsor company type (biotechnology or pharmaceutical). We find that the classification of a company as “early biotechnology” or “big pharmaceutical” had the most impact on abnormal returns, followed by properties such as disease, outcome, the phase of the clinical trial, and target accrual. We also find that these properties and classifications by themselves were insufficient to explain the variation in excess returns observed due to clinical trial outcomes.
An Artificial Intelligence-Based Industry Peer Grouping System
Bonne, George, Andrew W. Lo, Abilash Prabhakaran, Kien Wei Siah, Manish Singh, Xinxin Wang, Peter Zangari, and Howard Zhang (2022), An Artificial Intelligence-Based Industry Peer Grouping System, The Journal of Financial Data Science 4 (2), 1-3.
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In this article, the authors develop a data-driven peer grouping system using artificial intelligence (AI) tools to capture market perception and, in turn, group companies into clusters at various levels of granularity. In addition, they develop a continuous measure of similarity between companies; they use this measure to group companies into clusters and construct hedged portfolios. In the peer groupings, companies grouped in the same clusters had strong homogeneous risk and return profiles, whereas different clusters of companies had diverse, varying risk exposures. The authors extensively evaluated the clusters and found
that companies grouped by their method had higher out-of-sample return correlation but lower stability and interpretability than companies grouped by a standard industry classification system. The authors also develop an interactive visualization system for identifying AI-based clusters and similar companies.
Singh, Manish , Qingyang Xu, Sarah Wang, Tinah Hong, Mohammed Ghassemi, Andrew W. Lo (2022) Real-time Extended Psychophysiological Analysis of Financial Risk
Processing, PLoS ONE 17(7): e0
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We study the relationships between the real-time psychophysiological activity of professional traders, their financial transactions, and market fluctuations. We collected multiple physiological signals such as heart rate, blood volume pulse, and electrodermal activity of 55 traders at a leading global financial institution during their normal working hours over a nfive-day period. Using their physiological measurements, we implemented a novel metric of
trader’s “psychophysiological activation” to capture affect such as excitement, stress and irritation. We find statistically significant relations between traders’ psychophysiological activation levels and such as their financial transactions, market fluctuations, the type of financial products they traded, and their trading experience. We conducted post-measurement interviews with traders who participated in this study to obtain additional insights in the key
factors driving their psychophysiological activation during financial risk processing. Our work illustrates that psychophysiological activation plays a prominent role in financial risk processing for professional traders.
Should We Allocate More COVID-19 Vaccine Doses to Non-vaccinated Individuals?
Ben Chaouch, Zied, Andrew W. Lo, Chi Heem Wong (2022), Should we allocate more COVID-19 vaccine doses to non-vaccinated individuals?, PLOS Glob Public Health 2(7): e0000498.
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Following the approval by the FDA of two COVID-19 vaccines, which are administered in two doses three to four weeks apart, we simulate the effects of various vaccine distribution policies on the cumulative number of infections and deaths in the United States in the presence of shocks to the supply of vaccines. Our forecasts suggest that allocating more than 50% of available doses to individuals who have not received their first dose can significantly increase the number of lives saved and significantly reduce the number of COVID-19 infections. We find that a 50% allocation saves on average 33% more lives, and prevents on average 32% more infections relative to a policy that guarantees a second dose within the recommended time frame to all individuals who have already received their first dose. In fact, in the presence of supply shocks, we find that the former policy would save on average 8, 793 lives and prevents on average 607, 100 infections while the latter policy would save on average 6, 609 lives and prevents on average 460, 743 infections.
Siah, Kien Wei, Chi Heem Wong, Jerry Gupta, Andrew W. Lo (2022), Multimorbidity and mortality: A data science perspective, Journal of Multimorbidity and Comorbidity 12, 1-20.
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Background: With multimorbidity becoming the norm rather than the exception, the management of multiple chronic diseases is a major challenge facing healthcare systems worldwide.
Methods: Using a large, nationally representative database of electronic medical records from the United Kingdom spanning the years 2005–2016 and consisting over 4.5 million patients, we apply statistical methods and network analysis to identify comorbid pairs and triads of diseases and identify clusters of chronic conditions across different demographic groups. Unlike many previous studies, which generally adopt cross-sectional designs based on single snapshots of closed cohorts, we adopt a longitudinal approach to examine temporal changes in the patterns of multimorbidity. In addition, we perform survival analysis to examine the impact of multimorbidity on mortality.
Results: The proportion of the population with multimorbidity has increased by approximately 2.5 percentage points over the last decade, with more than 17% having at least two chronic morbidities. We find that the prevalence and the severity of multimorbidity, as quantified by the number of co-occurring chronic conditions, increase progressively with age. Stratifying by socioeconomic status, we find that people living in more deprived areas are more likely to be multimorbid compared to those living in more affluent areas at all ages. The same trend holds consistently for all years in our data. In general, hypertension, diabetes, and respiratory-related diseases demonstrate high in-degree centrality and eigencentrality, while cardiac disorders show high out-degree centrality.
Conclusions: We use data-driven methods to characterize multimorbidity patterns in different demographic groups and their evolution over the past decade. In addition to a number of strongly associated comorbid pairs (e.g., cardiac-vascular and cardiac-metabolic disorders), we identify three principal clusters: a respiratory cluster, a cardiovascular cluster, and a mixed cardiovascular-renal-metabolic cluster. These are supported by established pathophysiological mechanisms and shared risk factors, and largely confirm and expand on the results of existing studies in the medical literature. Our findings contribute to a more quantitative understanding of the epidemiology of multimorbidity, an important pre-requisite for developing more effective medical care and policy for multimorbid patients.
Alvarez, Daniel L., Lo and Andrew W. Lo (2022), Differentiated dollars, Nature Biotechnology, 1546-1696.
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Disease-focused foundations have used venture philanthropy (VP) for decades to develop interventions that have patient impact and generate revenue to support their mission. We articulate the distinguishing motives and features of VP funds and their distinct role in the life sciences innovation ecosystem. In particular, we focus on how entrepreneurs and VP funds can work together to help patients and generate economic value. We recommend that entrepreneurs seeking VP support understand a fund’s mission and objectives, and position themselves to fit the fund’s strategic and financial portfolio needs. Finally, we provide case studies of three specific initiatives — the JDRF T1D Fund, targeting type 1 (juvenile) diabetes; MPM Capital’s Oncology Impact Fund; and the American Heart Association’s Cardeation Capital — to showcase these efforts and benefits in practice.
Cummings, Jayna, Amanda Hu, Angela Su, and Andrew W. Lo (2022), Financing Alzheimer’s Disease Drug Development, In Alzheimer’s Disease Drug Development: Research and Development Ecosystem, edited by Jeffrey Cummings, Jefferson Kinney, and Howard Fillit, 465–479. Cambridge, UK: Cambridge University Press.
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Alzheimer’s disease (AD) is one of the biggest challenges to modern medicine. However, before February 2021, the last AD drug approval occurred in 2003, implying a 100% failure rate of AD therapeutic programs over the 17 years to that point; the lowest probability of success among all diseases. One of the key challenges is funding, which we explore in more depth in this chapter by first reviewing the current funding landscape for AD, and then considering the strengths and weaknesses of various commercialization strategies. Despite the discouraging track record of the biopharma industry in addressing AD, there is reason to be hopeful due to substantial scientific progress in developing a deeper understanding of the biology of the disease as well as increased federal funding for AD research. However, we also we need the private sector to translate these scientific breakthroughs into new medicines, which takes additional funding and new business models so as to reduce risk and improve returns for investors. If we can change the narrative of AD therapeutics to give investors new hope, the private sector can serve as a powerful partner to the biomedical community.