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History-Dependent Risk Attitude, Second Version

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  • David Dillenberger

    ()
    (Department of Economics, University of Pennsylvania)

  • Kareen Rozen

    ()
    (Department of Economics and Cowles Foundation for Research in Economics)

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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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 12-029.

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Length: 44 pages
Date of creation: 14 Feb 2011
Date of revision: 14 Jul 2012
Handle: RePEc:pen:papers:12-029

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Related research

Keywords: history-dependent risk attitude; reinforcement effect; primacy effect; dynamic reference dependence;

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  1. 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.
  2. 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.
  3. Rozen, Kareen, 2008. "Foundations of Intrinsic Habit Formation," Working Papers, Yale University, Department of Economics 40, Yale University, Department of Economics.
  4. Markku Kaustia & Samuli Knüpfer, 2008. "Do Investors Overweight Personal Experience? Evidence from IPO Subscriptions," Journal of Finance, American Finance Association, American Finance Association, vol. 63(6), pages 2679-2702, December.
  5. Alma Cohen & Liran Einav, 2005. "Estimating Risk Preferences from Deductible Choice," Discussion Papers, Stanford Institute for Economic Policy Research 04-031, Stanford Institute for Economic Policy Research.
  6. Mahmud Yesuf & Randall A. Bluffstone, 2009. "Poverty, Risk Aversion, and Path Dependence in Low-Income Countries: Experimental Evidence from Ethiopia," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, Agricultural and Applied Economics Association, vol. 91(4), pages 1022-1037.
  7. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780195102680, October.
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