fbpx Dynamic Loss Aversion, Growth, and Development | Harvard Kennedy School


  • Michael Kremer


Dynamic Loss Aversion, Growth, and Development, Michael Kremer, October 2014,Paper, We build a prospect-theoretic model to explain several stylized facts in the development literature. Agents get reference-dependent utility from the income generated by their assets, and are more aected by losses than by gains. Such agents may underinvest in novel or risky assets, leading to unexploited opportunities for high marginal returns, while simultaneously maintaining high holdings of low-return assets that they have owned in the past. There is a range of possible steady-state asset allocations, depending on past ownership, in contrast to conventional models of poverty traps. The provision of insurance against catastrophic loss will have a larger eect in motivating such agents to invest than it would on agents with classical preferences. We show how credit contract design can partially mitigate under-investment while simultaneouslyencouraging repayment of loans. Link