Learning to Reoptimize Consumption at New Income Levels: A Rationale for Prospect Theory
- 1 March 2004
- journal article
- Published by Oxford University Press (OUP) in Journal of the European Economic Association
- Vol. 2 (1) , 98-114
- https://doi.org/10.1162/154247604323015490
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 é nd her new optimal consump- tion 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. (JEL: D11)Keywords
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