Security, Potential, Goal Achievement, and Risky Choice Behavior

Abstract

This paper develops a new model for risky choice behavior — Target Utility Theory (TUT) — that shed light on several puzzles of the decision making and financial literatures. In particular, TUT can explain the experimental evidence related to goal seeking behavior (Payne et al., 1980), preference for security/potential (Levy and Levy, 2002), and the effect of prior outcomes on risky choice behavior (Thaler and Johnson, 1990). Moreover, TUT can provide a framework to rationalize phenomena observed in the financial markets, such as the escalation of commitment (Staw, 1981), the disposition effect (Shefrin and Statman, 1985), and the increase in risk taking by investors that are obtaining below target returns (Coval and Shumway, 2005). Running a Logit model on several results of the decision making literature, I find that TUT significantly improves with respect to: Prospect Theory, Expected Utility Theory, SP/A theory, Regret Theory, and Disappointment Aversion.