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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 (HDRA), allowing the attitude of a decision-maker (DM) towards risk at each stage of a T-stage lottery to evolve as a function of his history of disappointments and elations in prior stages. We establish an equivalence between the existence of an HDRA representation and two documented cognitive biases. First, the DM’s risk attitudes are reinforced by prior experiences: he becomes more risk averse after suffering a disappointment and less risk averse after being elated. Second, the DM displays a primacy effect: early outcomes have the strongest effect on risk attitude. Furthermore, the DM lowers his threshold for elation after a disappointing outcome and raises it after an elating outcome; this makes disappointment more likely after elation and vice-versa, leading to statistically reversing risk attitudes. “Gray areas” in the elation-disappointment assignment are connected to optimism and pessimism in determining endogenous reference points.

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Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 661465000000000184.

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Date of creation: 22 Sep 2010
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Handle: RePEc:cla:levrem:661465000000000184

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  1. 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.
  2. Kareen Rozen, 2010. "Foundations of Intrinsic Habit Formation," Econometrica, Econometric Society, Econometric Society, vol. 78(4), pages 1341-1373, 07.
  3. 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.
  4. Uzi Segal, 1989. "Two-Stage Lotteries Without the Reduction Axiom," UCLA Economics Working Papers, UCLA Department of Economics 552, UCLA Department of Economics.
  5. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, Econometric Society, vol. 59(3), pages 667-86, May.
  6. 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.
  7. Caplin, Andrew & Leahy, John, 1997. "Psychological Expected Utility Theory and Anticipatory Feelings," Working Papers, C.V. Starr Center for Applied Economics, New York University 97-37, C.V. Starr Center for Applied Economics, New York University.
  8. Andrew Ang & Geert Bekaert & Jun Liu, 2000. "Why Stocks May Disappoint," NBER Working Papers 7783, National Bureau of Economic Research, Inc.
  9. Ulrike Malmendier & Stefan Nagel, 2009. "Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking?," NBER Working Papers 14813, National Bureau of Economic Research, Inc.
  10. Machina, Mark J, 1989. "Dynamic Consistency and Non-expected Utility Models of Choice under Uncertainty," Journal of Economic Literature, American Economic Association, vol. 27(4), pages 1622-68, December.
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Cited by:
  1. 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.
  2. 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.

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