Learning to Reoptimize Consumption at New Income Levels: A Rationale for Prospect Theory

Citation:

Brunnermeier, Markus K. “Learning to Reoptimize Consumption at New Income Levels: A Rationale for Prospect Theory”. Journal of the European Economic Association 2 (2004): , 2, 98-114. Print.
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Number:

1

Abstract:

This paper provides a theoretical rationale for three experimental results of Prospect Theory: risk preferences are over gains and losses, loss aversion, and diminishing sensitivity. We consider a (boundedly rational) decision maker who does not find her new optimal consumption bundle with certainty when she is faced with a new income level. This alters her indirect utility function and makes her more risk averse at her current reference income level and less risk averse for a range of incomes below her reference income level.

Notes:

Rationalizes three elements of Prospect Theory.

See also: Behavioral
Last updated on 07/16/2014