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History-Dependent Risk Attitude

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  • David Dillenberger
  • Kareen Rozen

Abstract

We propose a model of history-dependent risk attitude, allowing a decision maker’s risk attitude to be affected by his history of disappointments and elations. The decision maker recursively evaluates compound risks, classifying realizations as disappointing or elating using a threshold rule. We establish equivalence between the model and two cognitive biases: risk attitudes are reinforced by experiences (one is more risk averse after disappointment than after elation) and there is a primacy effect (early outcomes have the greatest impact on risk attitude). In dynamic asset pricing, the model yields volatile, path-dependent prices.

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Paper provided by David K. Levine in its series Levine's Working Paper Archive with number 786969000000000066.

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Date of creation: 20 Mar 2011
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Handle: RePEc:cla:levarc:786969000000000066

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  1. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, Econometric Society, vol. 59(3), pages 667-86, May.
  2. Bellemare, C. & Krause, M. & Kroger, S. & Zhang, C., 2004. "Myopic Loss Aversion: Information Feedback vs. Investment Flexibility," Discussion Paper, Tilburg University, Center for Economic Research 2004-32, Tilburg University, Center for Economic Research.
  3. Machina, Mark J, 1989. "Dynamic Consistency and Non-expected Utility Models of Choice under Uncertainty," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 27(4), pages 1622-68, December.
  4. Segal, Uzi, 1990. "Two-Stage Lotteries without the Reduction Axiom," Econometrica, Econometric Society, Econometric Society, vol. 58(2), pages 349-77, March.
  5. Kareen Rozen, 2008. "Foundations of Intrinsic Habit Formation," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1642R, Cowles Foundation for Research in Economics, Yale University, revised Mar 2009.
  6. Ang, Andrew & Bekaert, Geert & Liu, Jun, 2005. "Why stocks may disappoint," Journal of Financial Economics, Elsevier, Elsevier, vol. 76(3), pages 471-508, June.
  7. Andrew Caplin & John Leahy, 2001. "Psychological Expected Utility Theory And Anticipatory Feelings," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 116(1), pages 55-79, February.
  8. Ulrike Malmendier & Stefan Nagel, 2011. "Depression Babies: Do Macroeconomic Experiences Affect Risk Taking?," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 373-416.
  9. Gordon, Stephen & St-Amour, Pascal, 1999. "A Preference Regime Model of Bull and Bear Markets," Cahiers de recherche, Université Laval - Département d'économique 9906, Université Laval - Département d'économique.
  10. Thierry Post & Martijn J. van den Assem & Guido Baltussen & Richard H. Thaler, 2008. "Deal or No Deal? Decision Making under Risk in a Large-Payoff Game Show," American Economic Review, American Economic Association, American Economic Association, vol. 98(1), pages 38-71, March.
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Cited by:
  1. Thomas M. Eisenbach & Martin C. Schmalz, 2013. "Up close it feels dangerous: 'anxiety' in the face of risk," Staff Reports, Federal Reserve Bank of New York 610, Federal Reserve Bank of New York.
  2. Shiri Artstein-Avidan & David Dillenberger, 2010. "Dynamic Disappointment Aversion: Don't Tell Me Anything Until You Know For Sure," PIER Working Paper Archive 10-025, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.

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