Affective decision making: a theory of optimism bias

Anat Bracha and Donald Brown ()

No 10-16, Working Papers from Federal Reserve Bank of Boston

Abstract: Optimism bias is inconsistent with the independence of decision weights and payoffs found in models of choice under risk, such as expected utility theory and prospect theory. Hence, to explain the evidence suggesting that agents are optimistically biased, we propose an alternative model of risky choice, affective decision making, where decision weights?which we label affective or perceived risk?are endogenized. Affective decision making (ADM) is a strategic model of choice under risk where we posit two cognitive processes?the \"rational\" and the \"emotional\" process. The two processes interact in a simultaneous-move intrapersonal potential game, and observed choice is the result of a pure Nash equilibrium strategy in this game. We show that regular ADM potential games have an odd number of locally unique pure strategy Nash equilibria, and demonstrate this finding for ADM in insurance markets. We prove that ADM potential games are refutable by axiomatizing the ADM potential maximizers.

Keywords: Insurance (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-cbe, nep-evo, nep-gth, nep-ias and nep-upt
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Affective decision making: A theory of optimism bias (2012)
Working Paper: Affective Decision-Making: A Theory of Optimism-Bias (2010)
Working Paper: Affective Decision-Making: A Theory of Optimism-Bias (2010)
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