A Retrieved-Context Theory of Financial Decisions

59 Pages Posted: 3 Sep 2019

See all articles by Jessica A. Wachter

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Michael J. Kahana

University of Pennsylvania - Department of Psychology

Multiple version iconThere are 2 versions of this paper

Date Written: August 2019

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 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.

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Suggested Citation

Wachter, Jessica A. and Kahana, Michael J., A Retrieved-Context Theory of Financial Decisions (August 2019). NBER Working Paper No. w26200. Available at SSRN: https://ssrn.com/abstract=3446510

Jessica A. Wachter (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
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National Bureau of Economic Research (NBER)

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Michael J. Kahana

University of Pennsylvania - Department of Psychology ( email )

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Philadelphia, PA 19104-6196
United States

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