History-Dependent Risk Attitude, Second Version
AbstractWe 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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Bibliographic InfoPaper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 12-029.
Length: 44 pages
Date of creation: 14 Feb 2011
Date of revision: 14 Jul 2012
history-dependent risk attitude; reinforcement effect; primacy effect; dynamic reference dependence;
Find related papers by JEL classification:
- D03 - Microeconomics - - General - - - Behavioral Economics; Underlying Principles
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
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