Essays in Behavioral Decision Theory

Many different behavioral phenomena that cannot be rationalized by standard models in economics have been well-documented both in the real world and in lab experiments. Motivated by these behavioral phenomena, the purpose of this dissertation is three-fold. First, I develop axiomatic models of individual decision-making to explain these well-documented phenomena. Second, I derive the implications and predictions of these axiomatic models for intertemporal choice, asset pricing, and other economic contexts. Third, I provide connections between these seemingly separate behavioral phenomena and widely-used properties of preferences in economics and psychology. This dissertation consists of five chapters. The first chapter studies dynamic choice under uncertainty. The second and third chapters study choice over multi-attribute alternatives. The fourth and fifth chapters study stochastic choice. The first chapter studies history-dependent risk aversion and focuses on a behavioral phenomenon called the reinforcement effect (RE), which states that people become less risk-averse after a good history than after a bad history. The RE is well-documented in consumer choices, financial markets, and lab experiments. I show that this seemingly anomalous behavior occurs whenever risk preferences are history-dependent (in a nontrivial way) and satisfy monotonicity with respect to first-order stochastic dominance. To study history-dependent risk aversion and the RE formally, I develop a behaviorally-founded model of dynamic choice under risk that generalizes standard discounted expected utility. To illustrate the usefulness of my model, I apply it to the Lucas tree model of asset pricing and draw implications of the RE for asset price dynamics. I find that, compared to history-independent models, assets are overpriced when the economy is in a good state and are underpriced in a bad state. Moreover, my model generates high, volatile, and predictable asset returns, and low and smooth bond returns, consistent with empirical evidence. In the second chapter, I develop an axiomatic model of reference-dependent preferences in which reference points are endogenous. In particular, I focus on choices from menus of two-attribute alternatives, and the reference point for a given menu is a vector that consists of the minimums of each dimension of the menu. I characterize this model by two weakenings of the Weak Axiom of Revealed Preference (WARP) in addition to standard axioms. My model is not just consistent with the attraction effect and the compromise effect, well-known preference reversals, but it also provides a connection between these two effects and diminishing sensitivity, a widely used behavioral property in economics. The model also provides bounds on preference reversals. I apply the model to two different contexts, intertemporal choice and risky choice, and diminishing sensitivity has interesting implications. In intertemporal choice, the main implication of the model is that borrowing constraints produce a psychological pressure to move away from the constraints even if they are not binding. In risky choice, the model allows conflicting risk behaviors. In the third chapter, I study choice over multidimensional alternatives. Making a choice between multidimensional alternatives is a difficult task. Therefore, a decision maker may adopt some procedure (heuristic) to simplify this task. I provide an axiomatic model of one such heuristic called the Intra-Dimensional Comparison (IDC) heuristic. The IDC heuristic is well-documented in the experimental literature on choice under risk. The IDC heuristic is a procedure in which a decision maker compares multidimensional alternatives dimension-by-dimension and makes a decision based on those comparisons. The model of the IDC heuristic provides a general framework applicable to many different contexts, including risky choice and social choice. The fourth chapter is joint work with Federico Echenique and Kota Saito. We develop an axiomatic theory of random choice that builds on Luce's (1959) model to incorporate a role for perception. We capture the role of perception through perception priorities; priorities that determine whether an object or alternative is perceived sooner or later than other alternatives. We identify agents' perception priorities from their violations of Luce's axiom of independence from irrelevant alternatives (IIA). The direction of the violation of IIA implies an orientation of agents' priority rankings. We adjust choice probabilities to account for the effects of perception, and impose that adjusted choice probabilities satisfy IIA. So all violations of IIA are accounted for by the perception order. The theory can explain some very well-documented behavioral phenomena in individual choice. We can also explain the effects of forced choice and choice overload in experiments. The fifth chapter studies how the ordering of alternatives (e.g., the location of products in a grocery store, the order of candidates on a ballot) affects a decision maker's choices. I develop an axiomatic model of random choice that builds on Luce's (1959) and incorporates the effect of the ordering of alternatives on choice frequencies. When the ordering of alternatives is observed, I characterize the model by two weakenings of IIA. When the ordering of alternatives is not observed, I can identify it from choice data. The model can accommodate the similarity, compromise, and attraction effects, violations of stochastic transitivity, and the choice overload, which are well-known behavioral phenomena in individual choice.