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Disappointment Cycles

Author

Listed:
  • David Dillenberger

    (Department of Economics, University of Pennsylvania)

  • Kareen Rozen

    (Department of Economics, Yale University and the Cowles Foundation for Research in Economics)

Abstract

We propose a model of history dependent disappointment aversion (HDDA), allowing the attitude of a decision-maker (DM) towards disappointment at each stage of a T-stage lottery to evolve as a function of his history of disappointments and elations in prior stages. We establish an equivalence between the existence of an HDDA representation and two documented cognitive biases. First, the DM overreacts to news: after suffering a disappointment, the DM lowers his threshold for elation and becomes more risk averse; similarly, after an elating outcome, the DM raises his threshold for elation and becomes less risk averse. This makes disappointment more likely after elation and vice-versa, leading to statistically cycling risk attitudes. Second, the DM displays a primacy effect: early outcomes have the strongest effect on risk attitude. “Gray areas†in the elation-disappointment assignment are connected to optimism and pessimism in determining endogenous reference points.

Suggested Citation

  • David Dillenberger & Kareen Rozen, 2010. "Disappointment Cycles," PIER Working Paper Archive 10-028, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    • Handle: RePEc:pen:papers:10-028
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    References listed on IDEAS

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    Cited by:

    1. Marianne Andries, 2012. "Consumption-based Asset Pricing Loss Aversion," 2012 Meeting Papers 571, Society for Economic Dynamics.

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    More about this item

    Keywords

    history dependent disappointment aversion; disappointment cycles; overreaction to news; primacy effect; endogenous reference dependence; optimism; pessimism;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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