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

Christian Gollier () and Alexander Muermann ()
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Alexander Muermann: Department of Finance, Accounting and Statistics, Vienna University of Economics and Business, A-1190 Wien, Austria

Management Science, 2010, vol. 56, issue 8, 1272-1284

Abstract: We propose a new decision criterion under risk in which individuals 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 compatible with first-degree and second-degree stochastic dominance and yield a preference for early resolution of uncertainty. Furthermore, they are consistent with observed violations of the independence axiom, such as the preference reversal in the Allais paradox, and predict that the decision maker takes on less risk compared to an expected utility maximizer. Our decision criterion can thus help explain the equity premium puzzle and the preference for low deductibles in insurance contracts.

Keywords: endogenous beliefs; anticipatory feeling; disappointment; optimism; decision under risk; portfolio allocation; insurance demand (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (36)

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Working Paper: Optimal Choice and Beliefs with Ex Ante Savoring and Ex Post Disappointment (2009)
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