Reference-dependent Loss Aversion Research Articles

Lying opportunities and incentives to lie: Reference dependence versus reputation

Recent experiments on lying behavior show that the lying frequency in case of low outcomes increases in the ex-ante probability of high outcomes. This finding is in line with models consisting of internal lying costs and external reputation costs and rejects certain other models, but does not allow for a clean test of models with reference dependent loss aversion. To compare the explanatory power of reputation models and loss aversion models, we manipulate the ex-ante probability that lying is possible at all. We show that the reputation model predicts that the lying frequency decreases in the probability that lying is possible, while the loss aversion model predicts the opposite. Our experimental results strongly support the reputation model. From an applied perspective, our results suggest that reducing the probability that lying is possible may be counterproductive.

Where You Stand Affects the Risks You Take: Socially Reference-Dependent Risk Attitudes

How does an individual’s position within a social distribution influence their desire to take risk? Reference-dependent loss aversion (Kahneman and Tversky, 1979; Koszegi and Rabin, 2006, 2007) adapted to a social setting, suggests that individuals may find risk more appealing when they are doing especially well or poorly compared to their peers. We examine the effects of social position on risk attitudes in a simple experiment which allows subjects to take risks at different locations in the social distribution against a realistic backdrop of real effort tasks. Subjects’ reference point under the loss aversion assumption is inferred from their empirical risk-taking patterns. Among subjects assigned to low expected earnings, we find a convex relationship in risk-taking across the social distribution when social information is available, consistent with a reference-point near the social median. For subjects assigned to high expected earnings, risk taking tends to be concave in social position, consistent with having a reference-point near the top of the social distribution. We find supporting evidence for our experimental findings using the National Longitudinal Survey of Youth (NLSY 97), in which similar patterns of risk tendencies across the income distribution are reported among individuals with lower and higher expected lifetime earnings, respectively. In finding different influential reference points among individuals with different expected earnings, our findings suggest that expectations influence reference point selection.

Staying ahead and getting even: Risk attitudes of experienced poker players

Frequent online poker players with extensive experience calculating probabilities and expected values might be expected to behave as Expected Utility maximizers, in that small shocks to their wealth would not affect risk preferences (Rabin, 2000). By contrast, reference-dependent loss aversion (as in Prospect Theory) (Koszegi and Rabin, 2006; Kahneman and Tversky, 1979) predicts that risk aversion decreases as wealth moves away from the reference point in either direction. In terms of continuing to play, as well as a more aggressive playing style, we find strong evidence for the break-even effect, the increased pursuit of risk as a player is losing within a session. Players' behavior also appears consistent with existing evidence on reference-dependent labor supply, in their tendency to reduce effort and risk-taking in response to being ahead. Our findings provide evidence for reference-dependent behavior in a flexible, high-skilled setting, under conditions of well-understood monetary risk.

Prospect Theory and the Financial Markets: A Review

The Prospect Theory as proposed by Kahneman and Tversky (1979) has emerged as a widely accepted theory of decision-making, thanks largely to the persistence of observed anomalies in the trading of financial products – specifically, the existence of an unusually large premium on equities, and the tendency to hold on to losing investments (disposition effect). Questions about the true nature and extent of reference-dependent loss aversion as manifested by these phenomena, however, remain. In particular, for countries like the Philippines with relatively shallow capital markets, there is a need to reconcile financial education and advice with the reality of systematically irrational investor sentiment to facilitate greater financial market participation.

Expressing Preferences in a Principal-Agent Task: A Comparison of Choice, Rating, and Matching

One of the more disturbing yet important findings in the social sciences is the observation that alternative tasks result in different expressed preferences among choice alternatives. We examine this problem not from the perspective of an individual making personal decisions, but from the perspective of an agent trying to follow the known values of a principal. In two studies, we train people to evaluate outcomes described by specific attributes and then examine their ability to express these known values with three common tasks: ratings of individual alternatives, choices among triples of alternatives, and matching pairs of alternatives to indifference. We find that each preference assessment method has distinct strengths and weaknesses. Ratings are quick, robust at following known values, and are perceived as an easy task by respondents. However, because ratings require projection to an imprecise response scale, respondents have difficulty when applying them to more complex preference structures. Further, they place too much weight on negative information, a result that is consistent with reference-dependent loss aversion. Choice is perceived as the most realistic task and the one about which people feel the most confident. However, choices exhibit the most negativity, which, in addition to flowing from the same perceptual bias of ratings, may be exacerbated by a screening strategy that excludes alternatives possessing the lowest level of an attribute. Finally, the matching task takes the most time and is perceived to be the most difficult. It shows minimal biases, except for one glaring flaw, a substantial overweighting of the matching variable. This bias is consistent with a well-known compatibility bias and suggests that agents can learn to use a matching task appropriately for all attributes except the matching variable itself. The article concludes with a discussion of the theoretical mechanisms by which these biases infiltrate different elicitation modes and a summary of managerial implications of these results.