Dynamic Choice, Independence and Emotions
Toulouse School of Economics (GREMAQ)
F. A. A. M. Van Winden
University of Amsterdam - Amsterdam School of Economics (ASE); CESifo (Center for Economic Studies and Ifo Institute); Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)
Tinbergen Institute Discussion Paper No. 06-087/1
CESifo Working Paper Series No. 1949
From the viewpoint of the independence axiom of expected utility theory, an interesting empirical dynamic choice problem involves the presence of a global risk, that is, a chance of losing everything whichever safe or risky option is chosen. In this experimental study, participants have to allocate real money between a safe and a risky project. Treatment variable is the particular decision stage at which a global risk is resolved: (i) before the investment decision; (ii) after the investment decision but before the resolution of the investment risk; (iii) after the resolution of the investment risk. The baseline treatment is without global risk. Our goal is to investigate the isolation effect and the principle of timing independence under the different timing options of the global risk. In addition, we examine the role played by anticipated and experienced emotions in the choice problem. Main findings are a violation of the isolation effect, and support for the principle of timing independence. Although behavior across the different global risk cases shows similarities, we observe clear differences in people's affective responses. This may be responsible for the conflicting results observed in earlier experiments. Dependent on the timing of the global risk different combinations of anticipated and experienced emotions influence decision making.
Number of Pages in PDF File: 44
Keywords: emotions, investment, global-risk, background risk, laboratory experiment, regret, anxiety
JEL Classification: A12, C91, D81
Date posted: October 14, 2006
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