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Optimal Choice and Beliefs with Ex Ante Savoring and Ex Post Disappointment

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  • Gollier, Christian
  • Muermann, Alexander

Abstract

We propose a new decision criterion under risk in which individuals extract both utility from anticipatory feelings ex ante and disutility from disappointment ex post. The decision maker chooses his degree of optimism, given that more optimism raises both the utility of ex ante feelings and the risk of disappointment ex post. We characterize the optimal beliefs and the preferences under risk generated by this mental process and apply this criterion to a simple portfolio choice/insurance problem. We show that these preferences are compatible with first-degree and second-degree stochastic dominance and yield a preference for early resolution of uncertainty. Furthermore, they are consistent with observed violations of the independence axiom, such as the preference reversal in the Allais paradox, and predict that the decision maker takes on less risk compared to an expected utility maximizer. Our decision criterion can thus help explain the equity premium puzzle and the preference for low deductibles in insurance contracts.

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Bibliographic Info

Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 462.

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Date of creation: 27 Mar 2006
Date of revision: 2009
Publication status: Published in Management Science, vol.�56, n°8, août 2010, p.�1272-1284.
Handle: RePEc:ide:wpaper:5897

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  1. Mark J Machina, 1982. ""Expected Utility" Analysis without the Independence Axiom," Levine's Working Paper Archive 7650, David K. Levine.
  2. Rothschild, Michael & Stiglitz, Joseph E., 1971. "Increasing risk II: Its economic consequences," Journal of Economic Theory, Elsevier, vol. 3(1), pages 66-84, March.
  3. Matthew Rabin, 2001. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Method and Hist of Econ Thought 0012001, EconWPA.
  4. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  5. Botond Koszegi & Matthew Rabin, 2005. "A Model of Reference-Dependent Preferences," Levine's Bibliography 784828000000000341, UCLA Department of Economics.
  6. Gollier Christian, 1995. "The Comparative Statics of Changes in Risk Revisited," Journal of Economic Theory, Elsevier, vol. 66(2), pages 522-535, August.
  7. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
  8. Kopczuk Wojciech & Slemrod Joel, 2005. "Denial of Death and Economic Behavior," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 5(1), pages 1-26, August.
  9. Andrew Ang & Geert Bekaert & Jun Liu, 2000. "Why Stocks May Disappoint," NBER Working Papers 7783, National Bureau of Economic Research, Inc.
  10. Akerlof, George A & Dickens, William T, 1982. "The Economic Consequences of Cognitive Dissonance," American Economic Review, American Economic Association, vol. 72(3), pages 307-19, June.
  11. Andrew Caplin & John Leahy, 2001. "Psychological Expected Utility Theory And Anticipatory Feelings," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 55-79, February.
  12. Miles S. Kimball, 1991. "Standard Risk Aversion," NBER Technical Working Papers 0099, National Bureau of Economic Research, Inc.
  13. Machina, Mark J, 1987. "Choice under Uncertainty: Problems Solved and Unsolved," Journal of Economic Perspectives, American Economic Association, vol. 1(1), pages 121-54, Summer.
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Cited by:
  1. Elyès Jouini & Paul Karehnke & Clotilde Napp, 2013. "On Portfolio Choice with Savoring and Disappointment," Post-Print halshs-00927267, HAL.
  2. Selima Benmansour & Elyès Jouini & Clotilde Napp & Jean-Michel Marin & Christian Robert, 2007. "Are risk averse agents more optimistic? A Bayesian estimation approach," Working Papers halshs-00163678, HAL.
  3. Foster, Gigi & Frijters, Paul & Johnston, David W., 2012. "The triumph of hope over disappointment: A note on the utility value of good health expectations," Journal of Economic Psychology, Elsevier, vol. 33(1), pages 206-214.
  4. Paul Frijters & Gigi Foster & David W. Johnston, 2012. "The triumph of hope over regret: A note on the utility value of good health expectations," Discussion Papers Series 451, School of Economics, University of Queensland, Australia.

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