Working Paper: NBER ID: w16387
Authors: Pedro Bordalo; Nicola Gennaioli; Andrei Shleifer
Abstract: We present a theory of choice among lotteries in which the decision maker's attention is drawn to (precisely defined) salient payoffs. This leads the decision maker to a context-dependent representation of lotteries in which true probabilities are replaced by decision weights distorted in favor of salient payoffs. By endogenizing decision weights as a function of payoffs, our model provides a novel and unified account of many empirical phenomena, including frequent risk-seeking behavior, invariance failures such as the Allais paradox, and preference reversals. It also yields new predictions, including some that distinguish it from Prospect Theory, which we test. We also use the model to modify the standard asset pricing framework, and use that application to explore the well-known growth/value anomaly in finance.
Keywords: salience; decision-making; risk; lotteries; preference reversals
JEL Codes: D03; D81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| salience (D91) | risk attitudes (D81) |
| salient payoffs (J33) | decision weights associated with lotteries (D81) |
| risk-seeking behavior when upside is salient (G41) | risk attitudes (D81) |
| risk-averse behavior when downside is salient (D91) | risk attitudes (D81) |
| changes in salience (D91) | preference reversals (D11) |
| salience (D91) | decision-making outcomes (D70) |