Optimal Choice and Beliefs with Ex Ante Savoring and Ex Post Disappointment

We propose a new decision criterion under risk in which people extract both utility from anticipatory feelings ex ante and disutility from disappointment ex post. The decision maker chooses his degree of optimism, given that more optimism raises both the utility of ex ante feelings and the risk of disappointment ex post. We characterize the optimal beliefs and the preferences under risk generated by this mental process and apply this criterion to a simple insurance/portfolio choice problem. The predictions of our model are consistent with the preference reversal in the Allais’ paradoxes, the equity premium puzzle, and the preference for low deductibles in insurance contracts.