Home About Latest Browse RSS Advanced Search

Federal Reserve Bank of Boston
Working Papers
Affective decision making: a theory of optimism bias
Anat Bracha
Donald J. Brown
Abstract

Optimism bias is inconsistent with the independence of decision weights and payoffs found in models of choice under risk, such as expected utility theory and prospect theory. Hence, to explain the evidence suggesting that agents are optimistically biased, we propose an alternative model of risky choice, affective decision making, where decision weights—which we label affective or perceived risk—are endogenized. Affective decision making (ADM) is a strategic model of choice under risk where we posit two cognitive processes—the "rational" and the "emotional" process. The two processes interact in a simultaneous-move intrapersonal potential game, and observed choice is the result of a pure Nash equilibrium strategy in this game. We show that regular ADM potential games have an odd number of locally unique pure strategy Nash equilibria, and demonstrate this finding for ADM in insurance markets. We prove that ADM potential games are refutable by axiomatizing the ADM potential maximizers.


Download Full text
Download Full text
Cite this item
Anat Bracha & Donald J. Brown, Affective decision making: a theory of optimism bias, Federal Reserve Bank of Boston, Working Papers 10-16, 2010.
More from this series
JEL Classification:
Subject headings:
Keywords: Insurance
For corrections, contact Catherine Spozio ()
Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal