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Disappointment Cycles

  • David Dillenberger

    ()

    (Department of Economics, University of Pennsylvania)

  • Kareen Rozen

    ()

    (Department of Economics, Yale University and the Cowles Foundation for Research in Economics)

We propose a model of history dependent disappointment aversion (HDDA), allowing the attitude of a decision-maker (DM) towards disappointment at each stage of a T-stage lottery to evolve as a function of his history of disappointments and elations in prior stages. We establish an equivalence between the existence of an HDDA representation and two documented cognitive biases. First, the DM overreacts to news: after suffering a disappointment, the DM lowers his threshold for elation and becomes more risk averse; similarly, after an elating outcome, the DM raises his threshold for elation and becomes less risk averse. This makes disappointment more likely after elation and vice-versa, leading to statistically cycling risk attitudes. Second, the DM displays a primacy effect: early outcomes have the strongest effect on risk attitude. “Gray areas” in the elation-disappointment assignment are connected to optimism and pessimism in determining endogenous reference points.

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File URL: http://economics.sas.upenn.edu/system/files/working-papers/10-028.pdf
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 10-028.

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Length: 35 pages
Date of creation: 06 Aug 2010
Date of revision:
Handle: RePEc:pen:papers:10-028
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  1. Segal, Uzi, 1990. "Two-Stage Lotteries without the Reduction Axiom," Econometrica, Econometric Society, vol. 58(2), pages 349-77, March.
  2. Caplin, Andrew & Leahy, John, 1997. "Psychological Expected Utility Theory and Anticipatory Feelings," Working Papers 97-37, C.V. Starr Center for Applied Economics, New York University.
  3. Rozen, Kareen, 2008. "Foundations of Intrinsic Habit Formation," Working Papers 40, Yale University, Department of Economics.
  4. 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.
  5. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
  6. repec:dgr:kubcen:200432 is not listed on IDEAS
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