History-Dependent Risk Attitude

45 Pages Posted: 14 Feb 2011 Last revised: 21 Feb 2013

See all articles by David Dillenberger

David Dillenberger

University of Pennsylvania - Department of Economics

Kareen Rozen

Brown University - Department of Economics

Date Written: February 20, 2013

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, Reinforcement effect, Primacy effect, Dynamic reference dependence

JEL Classification: D03, D81, D91

Suggested Citation

Dillenberger, David and Rozen, Kareen, History-Dependent Risk Attitude (February 20, 2013). PIER Working Paper No. 11-004; Cowles Foundation Discussion Paper No. 1763. Available at SSRN: https://ssrn.com/abstract=1761417 or http://dx.doi.org/10.2139/ssrn.1761417

David Dillenberger (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-1503 (Phone)

Kareen Rozen

Brown University - Department of Economics ( email )

64 Waterman Street
Providence, RI 02912
United States

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