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History-Dependent Risk Attitude

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://cowles.econ.yale.edu/P/cd/d17b/d1763.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1763.

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Length: 38 pages
Date of creation: Aug 2010
Date of revision: Jul 2012
Handle: RePEc:cwl:cwldpp:1763
Contact details of provider: Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
Phone: (203) 432-3702
Fax: (203) 432-6167
Web page: http://cowles.econ.yale.edu/

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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  1. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
  2. Kareen Rozen, 2008. "Foundations of Intrinsic Habit Formation," Levine's Working Paper Archive 122247000000002062, David K. Levine.
  3. Pascal St-Amour & Stephen Gordon, 2000. "A Preference Regime Model of Bull and Bear Markets," American Economic Review, American Economic Association, vol. 90(4), pages 1019-1033, September.
  4. Ulrike Malmendier & Stefan Nagel, 2009. "Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking?," NBER Working Papers 14813, National Bureau of Economic Research, Inc.
  5. Andrew Ang & Geert Bekaert & Jun Liu, 2000. "Why Stocks May Disappoint," NBER Working Papers 7783, National Bureau of Economic Research, Inc.
  6. 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.
  7. repec:dgr:kubcen:200432 is not listed on IDEAS
  8. Thierry Post & Martijn J. van den Assem & Guido Baltussen & Richard H. Thaler, 2008. "Deal or No Deal? Decision Making under Risk in a Large-Payoff Game Show," American Economic Review, American Economic Association, vol. 98(1), pages 38-71, March.
  9. Machina, Mark J, 1989. "Dynamic Consistency and Non-expected Utility Models of Choice under Uncertainty," Journal of Economic Literature, American Economic Association, vol. 27(4), pages 1622-68, December.
  10. Uzi Segal, 1989. "Two-Stage Lotteries Without the Reduction Axiom," UCLA Economics Working Papers 552, UCLA Department of Economics.
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