Authors:

  • Michael Kremer

Excerpt

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 a ected 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 e ect 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