Endogenous Risk Attitudes; Jakub Steiner (University of Zurich)

Abstract

We show in a model inspired by neuroscience that optimal perception strategy encodes rewards using an s-shaped encoding function and oversamples low-probability contingencies as in Kahneman and Tversky (1979). Whether the chosen perception strategy has implications to behaviour depends on the degree of decision-maker’s understanding of risk. It has no implications whenever the DM fully understands the decision problem and perception friction vanishes. If, however, the DM underrates the complexity of the decision problem, then perception strategy induces risk-attitudes that reflects its properties even for vanishing perception friction. The model delivers risk attitudes from Prospect theory and, additionally, predicts that risk-attitudes are enlarged by time pressure and attenuated by the anticipation of large risks.

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