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On Bounded Rationality and Risk Aversion

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  • Markus K Brunnermeier

Abstract

This paper describes the relationship between bounded rationality and risk aversion. It shows athat bounded rationality increases risk aversion at the reference income level and that there exists an income level below the reference income level where bounded rationality reduces risk aversion and may lead to risks loving behaviour. These theoretical results are in line with previous experimental results. A boundedly rational decision maker is modelled as an agent who makes decision errors in choosing the optimal consumption bundle or does not know precisely his/her own true preference ordering.

Suggested Citation

  • Markus K Brunnermeier, 1997. "On Bounded Rationality and Risk Aversion," FMG Discussion Papers dp255, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp255
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp255.pdf
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    References listed on IDEAS

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    5. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    6. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
    7. Hanemann, W Michael, 1991. "Willingness to Pay and Willingness to Accept: How Much Can They Differ?," American Economic Review, American Economic Association, vol. 81(3), pages 635-647, June.
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    Cited by:

    1. Raj Chetty, 2004. "Consumption Commitments, Unemployment Durations, and Local Risk Aversion," NBER Working Papers 10211, National Bureau of Economic Research, Inc.
    2. Li, Yan & Chen, Yefen & Shou, Biying & Zhao, Xiaobo, 2019. "Oligopolistic quantity competition with bounded rationality and social comparison," International Journal of Production Economics, Elsevier, vol. 211(C), pages 180-196.

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