Salience Theory of Choice Under Risk

Bordalo, Pedro, Gennaioli, Nicola and Shleifer, Andrei (2012) Salience Theory of Choice Under Risk. Quarterly Journal of Economics, 127 (3). pp. 1243-1285.

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.

Item Type: Article
Keywords: finance
Subject(s): Finance
Date Deposited: 11 Jul 2016 14:53
Last Modified: 22 Feb 2017 18:24
Funders: not applicable
URI: http://eureka.sbs.ox.ac.uk/id/eprint/6183

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