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Salience Theory of Choice Under Risk

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  • Pedro Bordalo
  • Nicola Gennaioli
  • Andrei Shleifer

Abstract

We present a theory of choice among lotteries in which the decision maker's attention is drawn to (precisely defined) salient payoffs. This leads the decision maker to a context-dependent representation of lotteries in which true probabilities are replaced by decision weights distorted in favor of salient payoffs. By specifying decision weights as a function of payoffs, our model provides a novel and unified account of many empirical phenomena, including frequent risk-seeking behavior, invariance failures such as the Allais paradox, and preference reversals. It also yields new predictions, including some that distinguish it from prospect theory, which we test. JEL Codes: D03, D81. Copyright 2012, Oxford University Press.

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Paper provided by Harvard University OpenScholar in its series Working Paper with number 29210.

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Handle: RePEc:qsh:wpaper:29210

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  1. Looney, Adam & Kroft, Kory & Chetty, Raj, 2009. "Salience and Taxation: Theory and Evidence," Scholarly Articles 9748525, Harvard University Department of Economics.
  2. Yusufcan Masatlioglu & Daisuke Nakajima & Erkut Y. Ozbay, 2012. "Revealed Attention," American Economic Review, American Economic Association, vol. 102(5), pages 2183-2205, August.
  3. Grether, David M. & Plott, Charles R., . "Economic Theory of Choice and the Preference Reversal Phenomenon," Working Papers 152, California Institute of Technology, Division of the Humanities and Social Sciences.
  4. Xavier Gabaix, 2011. "A Sparsity-Based Model of Bounded Rationality," NBER Working Papers 16911, National Bureau of Economic Research, Inc.
  5. Nicola Gennaioli & Andrei Shleifer, 2010. "What Comes to Mind," The Quarterly Journal of Economics, MIT Press, vol. 125(4), pages 1399-1433, November.
  6. Loomes, Graham & Sugden, Robert, 1983. "A Rationale for Preference Reversal," American Economic Review, American Economic Association, vol. 73(3), pages 428-32, June.
  7. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-96, March.
  8. John Leland, 2010. "Generalized Similarity Judgments: An Alternative Explanation for Choice Anomalies," Levine's Working Paper Archive 7644, David K. Levine.
  9. Botond Koszegi & Adam Szeidl, 2013. "A Model of Focusing in Economic Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 128(1), pages 53-104.
  10. Michael H. Birnbaum & Ulrich Schmidt, 2010. "Allais Paradoxes Can be Reversed by Presenting Choices in Canonical Split Form," Kiel Working Papers 1615, Kiel Institute for the World Economy.
  11. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
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