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Learning to Re-optimize Consumption at New Income Levels: A Rationale for Prospect Theory
| Reference: |
Journal of the
European Economic Association, (2004), 2(1), 98-114. |
| 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. |
| Keywords: |
Risk Aversion, Loss Aversion, Bounded Rationality, Behavioral Economics |
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