A Model of Anchoring and Adjustment for Decision-Making under Risk

53 Pages Posted: 14 May 2021 Last revised: 8 Feb 2024

See all articles by Johannes Gerd Jaspersen

Johannes Gerd Jaspersen

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management)

Christian König-Kersting

University of Innsbruck

Marc A. Ragin

University of Georgia; University of Georgia - Department of Insurance, Legal Studies, Real Estate

Date Written: February 7, 2024

Abstract

We introduce a general model of anchoring and adjustment for decision-making under risk. To evaluate a lottery, agents anchor on the unweighted average of the utils associated with all possible outcomes. They adjust from the anchor (insufficiently) using information on the outcomes' probabilities. The resulting model implies behavior which is observationally similar to established prospect theory models. However, it is not rank-dependent and naturally applies to lotteries with any given number of outcomes, including continuous lotteries. We test the implications of this model with an experiment and find empirical support - subjects more prone to anchoring also weight probabilities more strongly. In a set of lottery choices allowing for dominance violations, the plurality of these violations appear according to the pattern predicted by our model. We consider applications to decisions in simple lotteries, show how the model can explain several well-known choice anomalies, and apply it to the equity premium puzzle for which we offer an empirical calibration using historical data on asset returns. The anchoring model is a flexible tool for modeling a simplified choice process for decisions under risk.

Keywords: Decision Theory, Probability Weighting, Anchoring, Heuristics

JEL Classification: D11, D81, D91, G41

Suggested Citation

Jaspersen, Johannes Gerd and König-Kersting, Christian and Ragin, Marc A. and Ragin, Marc A., A Model of Anchoring and Adjustment for Decision-Making under Risk (February 7, 2024). Available at SSRN: https://ssrn.com/abstract=3845633 or http://dx.doi.org/10.2139/ssrn.3845633

Johannes Gerd Jaspersen (Contact Author)

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management) ( email )

Schackstr. 4
Munich, DE 80539
Germany

Christian König-Kersting

University of Innsbruck ( email )

Universitätsstraße 15
Innsbruck, Innsbruck 6020
Austria

Marc A. Ragin

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

610 S Lumpkin Street
Moore-Rooker A417
Athens, GA 30602-6254
United States
7067132775 (Phone)

University of Georgia ( email )

610 S Lumpkin Street
Moore-Rooker A417
Athens, GA 30602-6254
United States
7067132775 (Phone)

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