A Retrieved-Context Theory of Financial Decisions

Retrieved-context theory, as applied to financial decisions, is a concept that integrates insights from the field of human memory to interpret various phenomena observed in financial economics. This theory has been utilized to explain a range of evidence, including the influence of early life experiences on investment choices, the timing of financial crises, and other aspects of asset pricing and portfolio selection.

Influence of Early Life Experiences

One of the key areas where retrieved-context theory has been applied is in understanding how early life experiences shape an individual's investment behavior. This is based on the idea that memories from early life can be retrieved and influence current decision-making processes. The theory posits that these early experiences form a context that is later retrieved when making financial decisions, potentially leading to patterns in investment choices that are consistent across an individual's lifetime178.

Timing of Financial Crises

Another application of the theory is in explaining the timing and occurrence of financial crises. The theory suggests that the memory of past financial events can influence the behavior of investors and market participants, potentially leading to the clustering of financial crises. This is because the retrieval of past crisis-related memories can trigger risk-averse behavior or panic selling, which can exacerbate market downturns15.

Asset Pricing and Portfolio Choice

The theory has also been used to address issues in asset pricing and portfolio selection. It provides a framework for understanding why certain assets may be over- or under-priced, and how investors construct their portfolios. The retrieved-context theory posits that investors' decisions are influenced by the context in which past financial information is retrieved, which can affect their assessment of risk and return, leading to anomalies in asset pricing3.

Revisions and Extensions

Building on previous models of memory search, the retrieved-context theory has been revised to incorporate a more nuanced understanding of how memories are retrieved and how they influence decision-making. This includes considering the temporal context of memory retrieval and how it interacts with current decision-making processes9.

Conclusion

The application of retrieved-context theory to financial decisions offers a novel perspective that bridges the gap between cognitive psychology and financial economics. It provides a framework for understanding the role of memory in shaping financial behavior and offers insights into a variety of phenomena observed in the financial markets. This approach, as presented by Jessica A Wachter and Michael Jacob Kahana in their 2019 publication2, enriches the understanding of financial decision-making by incorporating the complex interplay between memory and choice.