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.
|Date of creation:||Aug 2010|
|Date of revision:||Jul 2012|
|Publication status:||Published in Journal of Economic Theory (May 2015), 157: 445-477|
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