Reference-dependent Preferences Research Articles

Do retail investors gamble more during lockdown?

AbstractRetail investors are known to favor stocks with lottery‐like features and trade too much. Less is known about their intertemporal demand and risk‐taking behavior in lottery‐type stocks. We use intraday transaction data between September 2019 and June 2020 from the Stock Exchange of Thailand to test how individual's risk attitude changes with respect to decline in their wealth prospects during the COVID‐19 lockdown. The behavior of the investors supports a reference dependent preference. Confronted with lowered wealth prospects, retail investors substantially reduce their underweighting in nonlottery stocks while increasing overweighting and turnover frequency in lottery stocks resulting in deteriorating portfolio performance.

Inequality and risk preference

AbstractThis paper studies the relationship between income inequality and risk taking. Increased income inequality is likely to enlarge the scope for upward comparisons and, in the presence of reference-dependent preferences, to increase willingness to take risks. Using a globally representative data set on risk preference in 76 countries, we empirically document that the distribution of income in a country has a positive and significant link with the preference for risk. This relationship is remarkably precise and holds across countries and individuals, as well as alternate measures of inequality. We find evidence of a steeper gradient between willingness to take risks and inequality for cognitively more able individuals who likely have a better assessment of inequality and for those who are dissatisfied with their income. We present results in favour of our mechanism, which suggests that falling behind one’s reference group increases the appetite for risk taking.

Economic Shocks and Populism

Abstract We study how voters’ preferences between a safe incumbent and a risky opponent change in the aftermath of a negative aggregate shock. With reference-dependent preferences, economically disappointed voters become risk lovers, and are hence attracted by the more risky candidate. Survey data from the German Socio-Economic Panel are consistent with our assumptions and theoretical predictions on voters’ behaviour.

“Tacit bundling” among rivals: Limited-availability bargains for loss-averse consumers

This paper derives a stochastic discount strategy that encourages the joint consumption of two partial-substitute goods. The seller of the less valuable product offers a limited-availability discount to consumers with reference-dependent preferences à la Kőszegi and Rabin (2006). The stochastic discount introduces uncertainty in the consumers’ outcomes and increases their willingness to pay. Due to market competition, such stochastic pricing is effective only when it induces consumers to purchase both products. The other seller, who can only use deterministic pricing, tacitly consents as he has no benefit from engaging in a price war. Thus, a collusive outcome – which harms consumer welfare – is achieved without any explicit coordination between the two sellers.

Live Game Attendance and the Desire for (Un)Certain Game Outcomes in Football: Evidence From the German 2. Bundesliga

Abstract: This study aims to analyze fans’ demand for live football matches in the German 2. Bundesliga, focusing on match-outcome uncertainty. To examine the decision to attend sporting events, a fixed effects regression and the Tobit model were used to test the uncertainty of game outcomes and reference-dependent preferences with loss aversion. The estimated fans’ demand for attending live football matches is represented by the logged attendance of 2,442 matches from the 2010/2011 to the 2017/2018 seasons of the 2. Bundesliga. Our findings indicate that fans prefer certain game outcomes over uncertain ones. In other words, reference-dependent preferences with loss aversion dominate the desire for close competition. We estimated our main model using various proxies of uncertainty as robustness checks, and the results confirmed our findings.

Reference Dependence in Queue Design and Pricing Strategies

This research investigates the effect of reference dependence on waiting times in service systems which formerly used a first-in-first-out (FIFO) service but have introduced a priority line with a fee. Our model combines reference-dependent gain-loss utility with standard customer utility, and we posit that customers are pleased with shorter-than-expected waiting times, whereas longer-than-expected times lead to dissatisfaction and an increased likelihood of balking. The study explores two scenarios: a captive customer system (CCS) and a noncaptive customer system (NCCS), with a focus on optimal pricing and segmentation strategies for revenue and social welfare maximization. The results reveal that, in a CCS, the service provider should implement observed and unobserved customer segmentation to optimize revenue and social welfare, respectively. In an NCCS, the impact of customer segmentation on revenue maximization depends on the value of regular customers, their loss reference-dependent preferences, and the system’s offered load. Alternatively, if the service provider seeks to maximize social welfare, the provider’s use of customer segmentation relies solely on the system’s offered load and customers’ reference-dependent preferences. Our findings also indicate that reference dependence can have varying impacts under different conditions, suggesting the effectiveness of tailored service and pricing strategies. Notably, a CCS generates more revenue than does an NCCS because of its captive nature, and, surprisingly, increasing the service rate can decrease revenue while improving social welfare. These insights have significant implications for service management strategies for a CCS and an NCCS. Funding: J. Liu was supported by the National Natural Science Foundation of China (General Program) [Grant 72071112]. J. Chen was supported by the National Natural Science Foundation of China (Major Program) [Grant 71490723]. Supplemental Material: The online appendix is available at https://doi.org/10.1287/serv.2023.0033 .

A Random Reference Model

We provide two nested models of random reference-dependent choice in which the reference point is endogenously determined by random processes. Random choice behavior is due to random reference points, even though, from the decision-maker’s viewpoint, choices are deterministic. Through a revealed preference exercise, we establish when and how one can identify the reference-dependent preferences and the random reference rule from observed choice data. We also present behavioral postulates that characterize the empirical content of our models. Lastly, we investigate an application of our model to Bertrand competition with differentiated products. (JEL D11, D91)

An aspirational perspective on the negative risk-return relationship

The existence of a negative risk-return relationship challenges the conventional wisdom of finance, which typically assumes a positive correlation between risk and return. Reference-dependent preferences, motivated by prospect theory, offer a possible explanation for this negative risk-return relation. However, as we demonstrate in this paper prospect theory does not provide a general explanation for this puzzle. We show that the expected utility theory with an aspiration level can effectively account for this phenomenon.

The study of brand loyalty and switching cost on OTT bundled service choice: Focusing on reference-dependent preferences in the saturated market

The pay-TV service providers have introduced over-the-top (OTT) bundled services to attract additional subscribers in a saturated market. However, the majority of consumers in South Korea tend to bundle pay-TV services with mobile phones and internet, engaging in these services through contractual agreements. Given the potential lock-in effect of such bundling, there is a likelihood of elevated switching costs for pay-TV services. To thoroughly assess the possibility of consumers switching to other services, it is crucial to consider factors such as brand loyalty, which is often represented by the lock-in effect. Switching costs and brand loyalty can be elucidated by the loss aversion effect, rooted in reference-dependent preferences. Therefore, this study obtained data through a discrete choice experiment on OTT bundled services and delved into consumer preferences for services using a reference-dependent choice model, with the currently used pay-TV service serving as the reference point. The findings indicated a notable high switching cost for pay-TV services, reaching up to a maximum of $25.8 per month, and brand loyalty was found to have a statistically significant impact on these costs. Consequently, it was concluded that the effectiveness of strategies aimed at attracting new subscribers through the introduction of OTT bundled services would likely be insignificant.

Additive vs. subtractive earning in shared human-robot work environments

The performance of robots working alongside humans might positively or negatively affect humans' earnings, depending on the economic setting. In a new real-effort lab experiment, we study the impact of economic conditions in hybrid human-robot workplaces on workers' effort provision and attitudes. In a previous subtractive-earnings experiment (Kshirsagar et al., 2019), subjects' expected earnings negatively depend on a robot's performance, while in our new additive-earnings experiment, they depend on the robot's performance positively. Both experiments are guided by a past human-human experiment and by a model of expectations-based reference-dependent preferences. As the theory predicts and as previously found, increasing robot performance discourages effort under subtractive earnings—but, as the theory also predicts and as we find here, this effect disappears and perhaps reverses under additive earnings. Additionally, increasing robot performance negatively affects subjects' perceptions of themselves and of their robotic coworker under subtractive earnings, but we find that these effects weaken or reverse under additive earnings. These findings suggest a relationship between workers' earning structures and robots' performance that should be considered when designing hybrid workplaces.

Round number reference points and irregular patterns in reported gross margins

AbstractWe find irregular patterns in the distribution of firms’ reported quarterly gross margin percentages. Specifically, there is significant bunching around percentage integers that are highly round (e.g., multiples of 10, such as 30%, 40%, etc.) or are neatly divisible (e.g., 25%, 75%), compared to what is predicted by counterfactual distributions. Further investigation reveals that highly round gross margin firms are smaller, exert higher effort, achieve higher productivity, have more difficult goals, and pay their CEOs with a higher portion of fixed income. We also find that highly round gross margins are associated with superior performance. Additionally, we do not find consistent evidence that highly round gross margin reference points are linked to external rewards. Collectively, our evidence is consistent with reference-dependent preferences for highly round gross margins likely being driven by intrinsic (rather than extrinsic) motivations.

Relative deprivation and financial risk taking✰

This study examines whether relative deprivation is associated with risk preference and behavior. Relative deprivation measured by the Yitzhaki and Deaton indices and financial risk-taking outcomes are obtained from a representative household survey of Korean adults. Results show that relative deprivation is negatively associated with risk aversion, and this association is significant for men and individuals who experienced increasing relative deprivation. However, relative deprivation is not associated with investment outcomes such as risky asset ownership and risky asset share of financial net worth. These results are consistent with reference-dependent preference and social-comparison model that incorporates social standing into utility function.

Reference-dependent preferences and probability judgments

This paper provides empirical evidence that probability judgments help explain a reference-dependent preference. It explains using the data for Tokyo Taxi drivers, which includes the respondents about psychological questions. Probability judgments based on a dual process to cognition means judgments and calculations of the probability when they determine something under uncertainty. It weakens the assumption that people have the same rationality. We permit the difference between cognition to rationality and probability judgments. These probability judgments relate to reference points and drivers' personalities and intuition, which influence decision-making and can explain several reference dependences. The difference of cognition to rationality also determines their reference dependence type. It uses Rational Experienced Inventory as the index of cognition to rationality. Frequentist type has different target variables with case type, subjective type, and fortune type. Each probability judgment type has each target as the reference point. Probability judgment types explain the type of cognition to rationality. This explains the endogeneity of reference dependence.

Equilibrium strategies and pricing for a congested system with opaque price and loss-averse customers

In this paper, we study a service provider with opaque price strategy who sells services to loss-averse customers in a congestion-prone facility. The opaque price strategy means that the service provider discloses a price range of services to potential customers through social media. Loss aversion aims to characterize customers' reference-dependent preferences. We analyze a queueing game model with the help of an M/M/1 queueing system and adopt the cutoff structure characterized by reservation price to represent the loss-averse customers' joining decision. Then, we derive the loss-averse customer's reservation price and queueing strategies at equilibrium. In addition, the service provider sets the price to maximize her profit. We obtain some insights into how customers' degree of loss aversion affects the service provider's optimal price. For example, customers with a higher degree of loss aversion on the waiting time and the payment would push the service provider to decrease the optimal price. Customers with a higher degree of loss aversion about the service reward would urge the service provider to increase the optimal price. Furthermore, considering the attachment effect, we obtain the lowest possible expected profit of the service provider.

Reference-dependent preferences and gasoline consumption in Thailand

Reference-dependent preferences and gasoline consumption in Thailand

The Real Effects of Reference-dependent Preferences: Evidence from Mergers and Acquisitions

The Real Effects of Reference-dependent Preferences: Evidence from Mergers and Acquisitions

Expectations-Based Loss Aversion May Help Explain Seemingly Dominated Choices in Strategy-Proof Mechanisms

Deferred acceptance (DA), a widely implemented algorithm, is meant to improve allocations: under classical preferences, it induces preference-concordant rankings. However, recent evidence shows that—in both real, large-stakes applications and experiments—participants frequently play seemingly dominated, significantly costly strategies that avoid small chances of good outcomes. We show theoretically why, with expectations-based loss aversion, this behavior may be partly intentional. Reanalyzing existing experimental data on random serial dictatorship (a restriction of DA), we show that such reference-dependent preferences, with a degree and distribution of loss aversion that explain common levels of risk aversion elsewhere, fit the data better than no-loss-aversion preferences. (JEL D11, D82, D91)

Interactions of Framing and Timing in Nudging Online Game Security

Previous studies on applying the framing effects to cybersecurity nudges have shown that slight wording adjustments can predictably alter users’ security and privacy preferences. However, the applications mostly focus on the Reference-dependent preference, whereas limited information is available about another important embodiment, the Pseudo-certainty effect. In addition, it is also suggested that the framing effects are sensitive to the context, whereas known contributing contextual factors are limited. To solve the problems, we examine framing effects in cybersecurity in depth by designing two framing nudges based on the Pseudo-certainty effect and exploring their interactions with a contextual factor, timing. A between-subjects field experiment with 182 participants was conducted on a self-developed game to investigate the effectiveness of the framing nudges and timing in improving online game security. The participants were prompted to decide whether to set a game password. The results indicate that the framing of security warnings significantly affects users’ security decisions and behaviors, although their effects are moderated by the timing at which the warnings are presented. Finally, we conclude with practical security warning design implications.

Tax Evasion, Behavioral Microsimulation Models and Flat-Rate Tax Reforms: Analysis for Italy

It is sometimes argued that a flat-rate tax reform can reduce tax noncompliance. The argument is, however, inconsistent with the so-called Yitzhaki’s puzzle of the classical expected utility (EU) model. The latter predicts an increase, rather than a reduction, in tax evasion following a cut in the tax rates resulting from a flat-rate reform. We study the impact of a flat-rate tax in a microsimulation tax-benefit model of Italy, which allows us to analyze various hypotheses of tax evasion behavior. In addition to the EU model, we analyze expected utility with rank dependent probabilities (EURDP) and the model of reference dependent (RD) preference, the most favorable to overturn Yitzhaki’s puzzle. Our simulations show that a flat-rate tax would barely reduce overall evasion in Italy in all models considered. Redistributive effects are in all cases, large.

Are preferences for work reference dependent or time nonseparable? New experimental evidence

Tests of labor supply models often rely on wages. However, wage variation alone generally cannot disentangle the classical time separable model and its extensions: reference dependent preferences (income targeting) and time nonseparable preferences (disutility spillovers; timing-specific preferences). We set up a novel laboratory experiment in which individuals choose their working time. We vary, independently, wages, historical income paths, and cumulative past work. We also vary the timing of experimental sessions. Statistical tests and stochastic revealed preference methods cannot reject the classical model in favor of income targeting or disutility spillovers, but the data suggest that labor supply varies by time-of-the-day.