Searching for the Reference Point

Aurélien Baillon,Vitalie Spinu,Han Bleichrodt

doi:10.1287/mnsc.2018.3224

Abstract

Although reference dependence plays a central role in explaining behavior, little is known about the way that reference points are selected. This paper identifies empirically which reference point people use in decision under risk. We assume a comprehensive reference-dependent model that nests the main reference-dependent theories, including prospect theory, and that allows for isolating the reference point rule from other behavioral parameters. Our experiment involved high stakes with payoffs up to a week’s salary. We used an optimal design to select the choices in the experiment and Bayesian hierarchical modeling for estimation. The most common reference points were the status quo and a security level (the maximum of the minimal outcomes of the prospects in a choice). We found little support for the use of expectations-based reference points. This paper was accepted by David Simchi-Levi, decision analysis.

Highlights

A key insight of behavioral decision making is that people evaluate outcomes as gains and losses from a reference point
Our results indicate that two reference point rules stand out: the Status Quo and MaxMin, a security-based rule according to which subjects adopt the maximum outcome that they can reach for sure as their reference point (Schneider and Day 2018)
Reference dependence is a key concept in explaining people’s choices, but little insight exists into the question of which reference point people use

Summary

Introduction

A key insight of behavioral decision making is that people evaluate outcomes as gains and losses from a reference point. Reference dependence is central in prospect theory, the most influential descriptive theory of decision under risk, and it plays a crucial role in explaining people’s attitudes toward risk (Rabin 2000, Wakker 2010). Evidence abounds, from both the laboratory and the field, that preferences are reference dependent.. 1046–1047) argued that “ the reference point usually corresponds to the decision maker’s current position it can be influenced by aspirations, expectations, norms, and social comparisons.” This lack of clarity is undesirable, because it creates extra freedom in deriving predictions, making it impossible to rigorously test reference-dependent theories empirically. I do not have such a rule and formula.” Tversky and Kahneman (1991, pp. 1046–1047) argued that “ the reference point usually corresponds to the decision maker’s current position it can be influenced by aspirations, expectations, norms, and social comparisons.” This lack of clarity is undesirable, because it creates extra freedom in deriving predictions, making it impossible to rigorously test reference-dependent theories empirically.

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Discussion

Conclusion