Disappointment Cycles

David Dillenberger () and Kareen Rozen ()
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David Dillenberger: Department of Economics, University of Pennsylvania

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

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.

Keywords: history dependent disappointment aversion; disappointment cycles; overreaction to news; primacy effect; endogenous reference dependence; optimism; pessimism (search for similar items in EconPapers)
JEL-codes: D03 D81 D91 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2010-08-06
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Citations: View citations in EconPapers (1)

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