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On bounded rationality and risk aversion

Brunnermeier, Markus (1997) On bounded rationality and risk aversion. Financial Markets Group Discussion Papers (255). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

Experimental evidence suggests that agents who consume at their usual income level are very risk averse, whereas at lower income levels they often become risk loving. This paper provides a theoretical rationale for these experimental results. It shows that bounded rationality increases risk aversion at the reference income level. However, there is a range of lower income levels at which bounded rationality reduces risk aversion. A decision maker is boundedly rational if he, facing a new income, does not ̄nd his new optimal consumption bundle with certainty. This alters his indirect utility function and thus his attitude towards income lotteries. Bounded rationality is modelled in two ways. In the random choice approach the decision maker errs in choosing the new consumption bundle, while in the random utility approach he does not know precisely which bundle is his optimal one.

Item Type: Monograph (Discussion Paper)
Official URL: https://www.fmg.ac.uk/
Additional Information: © 1997 The Author(s)
Divisions: Financial Markets Group
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
JEL classification: D - Microeconomics > D1 - Household Behavior and Family Economics > D11 - Consumer Economics: Theory
Date Deposited: 23 Jun 2023 09:06
Last Modified: 16 Sep 2023 00:03
URI: http://eprints.lse.ac.uk/id/eprint/119155

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