CFDP 1763

History-Disappointment Risk Attitude

Publication Date: August 2010

Revision Date: February 2013

Pages: 44

Abstract: 

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.

Keywords: 

History-dependent risk attitude, Statistically reversing risk attitudes, Reinforcement effect, Primacy effect, Endogenous reference dependence, Betweenness, Optimism, Pessimism

JEL Classification Codes:  D03, D81, D91

See CFP: 1472