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History-Dependent Risk Attitude

  • David Dillenberger
  • Kareen Rozen

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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File URL: http://www.econ.yale.edu/~kr287/DillenbergerRozen-DisappointmentCycles.pdf
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Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 661465000000000184.

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Date of creation: 22 Sep 2010
Handle: RePEc:cla:levrem:661465000000000184
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