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Optimistic versus Pessimistic--Optimal Judgemental Bias with Reference Point

  • Si Chen
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This paper develops a model of reference-dependent assessment of subjective beliefs in which loss-averse people optimally choose the expectation as the reference point to balance the current felicity from the optimistic anticipation and the future disappointment from the realisation. The choice of over-optimism or over-pessimism depends on the real chance of success and optimistic decision makers prefer receiving early information. In the portfolio choice problem, pessimistic investors tend to trade conservatively, however, they might trade aggressively if they are sophisticated enough to recognise the biases since low expectation can reduce their fear of loss.

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File URL: http://arxiv.org/pdf/1310.2964
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Paper provided by arXiv.org in its series Papers with number 1310.2964.

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Date of creation: Oct 2013
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Handle: RePEc:arx:papers:1310.2964
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  1. Friedman, James W. & Mezzetti, Claudio, 2005. "Random belief equilibrium in normal form games," Games and Economic Behavior, Elsevier, vol. 51(2), pages 296-323, May.
  2. Eliaz, Kfir & Spiegler, Ran, 2006. "Can anticipatory feelings explain anomalous choices of information sources?," Games and Economic Behavior, Elsevier, vol. 56(1), pages 87-104, July.
  3. Brunnermeier, Markus K & Gollier, Christian & Parker, Jonathan A, 2007. "Optimal Beliefs, Asset Prices and the Preference for Skewed Returns," CEPR Discussion Papers 6181, C.E.P.R. Discussion Papers.
  4. 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.
  5. Jonathan Parker & Markus K Brunnermeier, 2002. "Optimal Expectations," FMG Discussion Papers dp434, Financial Markets Group.
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  7. Botond Koszegi & Matthew Rabin, 2004. "A Model of Reference-Dependent Preferences," Method and Hist of Econ Thought 0407001, EconWPA.
  8. Benabou, R. & Tirole, J., 2001. "Willpower and Personal Rules," Papers 216, Princeton, Woodrow Wilson School - Public and International Affairs.
  9. 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.
  10. Guy Mayraz, 2013. "Wishful Thinking," Department of Economics - Working Papers Series 1172, The University of Melbourne.
  11. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
  12. Botond Koszegi & Matthew Rabin, 2009. "Reference-Dependent Consumption Plans," American Economic Review, American Economic Association, vol. 99(3), pages 909-36, June.
  13. Larry Epstein & Igor Kopylov, 2006. "Cognitive Dissonance and Choice," RCER Working Papers 525, University of Rochester - Center for Economic Research (RCER).
  14. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  15. B. Douglas Bernheim & Raphael Thomadsen, 2005. "Memory and Anticipation," Economic Journal, Royal Economic Society, vol. 115(503), pages 271-304, 04.
  16. Camerer, Colin & Weber, Martin, 1992. " Recent Developments in Modeling Preferences: Uncertainty and Ambiguity," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 325-70, October.
  17. Guy Mayraz, 2011. "Priors and Desires," CEP Discussion Papers dp1047, Centre for Economic Performance, LSE.
  18. Matthew Rabin., 1991. "Cognitive Dissonance and Social Change," Economics Working Papers 91-180, University of California at Berkeley.
  19. Nicholas Barberis & Ming Huang, 2008. "Stocks as Lotteries: The Implications of Probability Weighting for Security Prices," American Economic Review, American Economic Association, vol. 98(5), pages 2066-2100, December.
  20. Caplin, A. & Leahy, J., 1999. "The Supply of Information by a Concerned Expert," Working Papers 99-08, C.V. Starr Center for Applied Economics, New York University.
  21. Loewenstein, George, 1987. "Anticipation and the Valuation of Delayed Consumption," Economic Journal, Royal Economic Society, vol. 97(387), pages 666-84, September.
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