A Retrieved-Context Theory of Financial Decisions

97 Pages Posted: 6 Nov 2019 Last revised: 25 Aug 2023

See all articles by Jessica A. Wachter

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER); Securities and Exchange Commission

Michael J. Kahana

University of Pennsylvania - Department of Psychology

Multiple version iconThere are 2 versions of this paper

Date Written: June 25, 2023

Abstract

Studies of human memory indicate that features of an event evoke memories of prior associated contextual states, which in turn become associated with the current event's features. This retrieved-context mechanism allows the remote past to influence the present, even as agents gradually update their beliefs about their environment. We apply a version of retrieved context theory, drawn from the literature on human memory, to explain three types of evidence in the financial economics literature: the role of early life experience in shaping investment choices, occurrence of financial crises, and the impact of fear on asset allocation. These applications suggest a recasting of neoclassical rational expectations in terms of beliefs as governed by principles of human memory.

Keywords: Memory, Context, Under-reaction, Financial Disasters

JEL Classification: D03, D81, G02, G11, G12

Suggested Citation

Wachter, Jessica A. and Kahana, Michael J., A Retrieved-Context Theory of Financial Decisions (June 25, 2023). 10th Miami Behavioral Finance Conference, Available at SSRN: https://ssrn.com/abstract=3333248 or http://dx.doi.org/10.2139/ssrn.3333248

Jessica A. Wachter (Contact Author)

University of Pennsylvania - Finance Department ( email )

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Michael J. Kahana

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