Document Type

Working Paper

Publication Date

7-2016

Working Paper Number

2016-01

JEL Codes

D81, E44, G32

Abstract

We propose a behavioral model in which an agent’s attitude toward loss is affected by memories of prior losses. Due to the availability heuristic, memories of prior loss sensitize the agent and increase the weight assigned to prospective losses. Because memories of firsttime experiences exhibit multi-decade persistence in recall, our model helps explain recent empirical findings that major events can have multi-decade effects on choices. We further demonstrate consistency with stochastic dominance, so that sensitized individuals will prefer distributions demonstrating first- and second-order stochastic dominance. In an overlapping generations version of Tirole’s (2006) liquidity-scale framework, our model generates procyclical investment.

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