Studies of human memory indicate that features of an event evoke memories of prior associated contextual states, which in turn become associated with the current event's features. This retrieved-context mechanism allows the remote past to influence the present, even as agents gradually update their beliefs about their environment. We apply a version of retrieved context theory, drawn from the literature on human memory, to explain three types of evidence in the financial economics literature: the role of early life experience in shaping investment choices, occurrence of financial crises, and the impact of fear on asset allocation. These applications suggest a recasting of neoclassical rational expectations in terms of beliefs as governed by principles of human memory.
Bio: Jessica A. Wachter is the Dr. Bruce I. Jacobs Professor in Quantitative Finance at the Wharton School of Business of the University of Pennsylvania. She is currently on leave at the Securities and Exchange Commission where she serves as Chief Economist and Director of the Division of Economic and Risk Analysis. She holds a PhD in Business Economics and an undergraduate degree in Mathematics from Harvard University. She currently serves on the board of the Western Finance Association, and as an associate editor of Quantitative Economics. Previously, she served as associate editor at the Review of Financial Studies and the Journal of Economic Theory and as a board member of the American Finance Association. Her research interests include asset pricing models that incorporate rare events and behavioral finance. She has published numerous papers in the Journal of Finance, the Journal of Financial Economics, the Review of Financial Studies, and other journals.
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