Affective Decision-Making: A Theory of Optimism-Bias

Anat Bracha and Donald J. Brown ()
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Donald J. Brown: Department of Economics, Yale University, https://economics.yale.edu/people/emeritus/donald-j-brown

No 1759, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

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" processes. The two processes interact in a simultaneous-move intrapersonal potential game, and observed choice is the result of a pure strategy Nash equilibrium in this potential game. We show that regular ADM potential games have an odd number of locally unique pure strategy Nash equilibria, and demonstrate this finding for affective decision making in insurance markets. We prove that ADM potential games are refutable, by axiomatizing the ADM potential maximizers.

Keywords: Affective decision-making; Optimism-bias; ADM potential games; Demand for insurance (search for similar items in EconPapers)
JEL-codes: D01 D81 G22 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2010-03
New Economics Papers: this item is included in nep-cbe, nep-gth, nep-ias, nep-neu 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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