Optimal Choice and Beliefs with Ex Ante Savoring and Ex Post Disappointment

Christian Gollier () and Alexander Muermann ()
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Alexander Muermann: University of Pennsylvania, The Wharton School

No 2006/28, CFS Working Paper Series from Center for Financial Studies

Abstract: We propose a new decision criterion under risk in which people extract both utility from anticipatory feelings ex ante and disutility from disappointment ex post. The decision maker chooses his degree of optimism, given that more optimism raises both the utility of ex ante feelings and the risk of disappointment ex post. We characterize the optimal beliefs and the preferences under risk generated by this mental process and apply this criterion to a simple portfolio choice/insurance problem. We show that these preferences are consistent with the preference reversal in the Allais’ paradoxes and predict that the decision maker takes on less risk compared to an expected utility maximizer. This speaks to the equity premium puzzle and to the preference for low deductibles in insurance contracts. Keywords: endogenous beliefs, anticipatory feeling, disappointment, optimism, decision under risk, portfolio allocation.

Keywords: Endogenous Beliefs; Anticipatory Feeling; Disappointment; Optimism; Decision Under Risk; Portfolio Allocation (search for similar items in EconPapers)
JEL-codes: D81 G11 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-upt
Date: 2006-12-08
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Working Paper: Optimal Choice and Beliefs with Ex Ante Savoring and Ex Post Disappointment (2006)
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