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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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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
Publication status: Published in Journal of Economic Theory (May 2015), 157: 445-477
Handle: RePEc:cwl:cwldpp:1763
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Yale University, Box 208281, New Haven, CT 06520-8281 USA

Phone: (203) 432-3702
Fax: (203) 432-6167
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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  27. Young Han Lee & Ulrike Malmendier, 2007. "The Bidder's Curse," NBER Working Papers 13699, National Bureau of Economic Research, Inc.
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  29. Alberto Alesina & Nicola Fuchs-Schündeln, 2007. "Goodbye Lenin (or Not?): The Effect of Communism on People," American Economic Review, American Economic Association, vol. 97(4), pages 1507-1528, September.
  30. Andrew Caplin & John Leahy, 2001. "Psychological Expected Utility Theory and Anticipatory Feelings," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 55-79.
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