History-Dependent Risk Attitude
45 Pages Posted: 14 Feb 2011 Last revised: 21 Feb 2013
Date Written: February 20, 2013
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: Suggested Citation