A Retrieved-Context Theory of Financial Decisions
58 Pages Posted: 26 Feb 2019 Last revised: 9 Aug 2019
Date Written: August 7, 2019
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 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 four problems in asset pricing and portfolio choice: over-persistence of beliefs, providence of financial crises, price momentum, and the impact of fear on asset allocation. These examples suggest a recasting of neoclassical rational expectations in terms of beliefs as governed by principles of human memory.
Keywords: Memory, Context, Momentum, Financial Disasters
JEL Classification: D03, D81, G02, G11, G12
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