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History-Dependent Risk Attitude

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  • David Dillenberger

    ()
    (Department of Economics, University of Pennsylvania)

  • Kareen Rozen

    ()
    (Department of Economics, Yale University and Cowles Foundation for Research in Economics)

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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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 11-004.

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Length: 39 pages
Date of creation: 14 Feb 2011
Date of revision:
Handle: RePEc:pen:papers:11-004

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Keywords: history-dependent risk attitude; statistically reversing risk attitudes; reinforcement effect; primacy effect; endogenous reference dependence; betweenness; optimism; pessimism;

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  1. Ulrike Malmendier & Stefan Nagel, 2009. "Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking?," NBER Working Papers 14813, National Bureau of Economic Research, Inc.
  2. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, Econometric Society, vol. 59(3), pages 667-86, May.
  3. Uzi Segal, 2000. "Two Stage Lotteries Without the Reduction Axiom," Levine's Working Paper Archive 7599, David K. Levine.
  4. 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.
  5. 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.
  6. Bellemare, Charles & Krause, Michaela & Kroger, Sabine & Zhang, Chendi, 2005. "Myopic loss aversion: Information feedback vs. investment flexibility," Economics Letters, Elsevier, Elsevier, vol. 87(3), pages 319-324, June.
  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. 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.
  10. Pascal St-Amour & Stephen Gordon, 2000. "A Preference Regime Model of Bull and Bear Markets," American Economic Review, American Economic Association, American Economic Association, vol. 90(4), pages 1019-1033, September.
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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, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 10-025, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.

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