A Satisficing Alternative to Prospect Theory

Abstract:     
Motivated by extensive research suggesting that aspiration levels play a central role in the decision making of many individuals, we introduce a target-based model of risky choice. A key aspect of the model is the decision maker's attitude towards risk: when prospects appear favorable relative to the target, the decision maker behaves in a risk averse way. In sufficiently dire circumstances, however, prospects may be in danger of failing to meet the target, and the decision maker can display "risk-seeking" behavior. By incorporating both targets and such a switch between risk attitudes, the approach can be viewed as a hybrid model, capturing in spirit the celebrated ideas of both satisficing and prospect theory. The model is simple to motivate and applicable in settings where target attainment is of central concern to the decision maker. We show that such an approach is a natural dual to one based on risk measures. We establish structural properties, such as stochastic dominance, and show that the model has a general interpretation in terms of an index ranking prospects in the face of distributional ambiguity. Finally, though the model is simple and not designed with a specific intent to address any puzzles of decision theory, an interesting byproduct is that it can accommodate a number of "paradoxes," both neoclassical and classical (e.g., Allais and Ellsberg).

Keywords: satisficing, aspiration levels targets, prospect theory, reflection effect, risk measures, coherent risk measures, convex risk measures, portfolio optimization

JEL Classifications: D81, G11

Working Paper Series