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Randomizing Endowments: An Experimental Study of Rational Expectations and Reference-Dependent Preferences
Abstract
We test expectations-based reference dependence in market experiments with probabilistic forced exchange. Koszegi and Rabin (2006 ) predict that when the probability of forced exchange increases, individuals cannot expect to stick with the status quo, and should grow more willing to exchange. This mechanism may eliminate and even reverse the "endowment effect" (Knetsch and Sinden 1984; Kahneman, Knetsch, and Thaler 1990 ). In a series of experiments with overall 930 subjects, we show some tentative support for the notion that attitudes toward exchange are influenced by the probability of forced exchange. However, the results are sensitive to small changes in experimental design.
... Our approach differs in that we use a between-subjects design where we do not disclose the varying RBP distributions to all subjects in advance, as was done in Mazar et al. (2013), or sequentially as in Tymula et al. (2016), to avoid experiment-wise expectations being held constant or influenced by prior decisions and outcomes. Also our focus remains strictly within the confines of the BDM mechanism, intentionally avoiding the introduction of external, non-price based lotteries that might alter the nature of the BDM mechanism and introduce variables not typically present in standard BDM experiments (Cerulli-Harms et al., 2019;Marzilli Ericson & Fuster, 2011;Smith, 2008Smith, , 2012. ...
... To incorporate expectations in our framework, we examine bids in the BDM mechanism using Kőszegi and Rabin's (2007) notion of unacclimating personal equilibrium (UPE) that is based on a model similar to prospect theory (Kahneman & Tversky, 1979;Tversky & Kahneman, 1991) but where the reference points are formed by expectations, rather than the status-quo. 13 Similar to Cerulli-Harms et al. (2019) and Marzilli Ericson and Fuster (2011), we choose UPE and not the choice acclimating personal equilibrium (CPE) because it is more appropriate in situations where uncertainty is resolved shortly after the decision (Kőszegi and Rabin, 2007). We feel that the small time lapse between submitting the bid and learning the price during the experiment falls under the category of a "short" period of time, justifying the use of UPE. ...
... Regarding expectations, the behaviors we observed align with the body of literature, including studies by Banerji and Gupta (2014), Karle et al. (2015), Marzilli Ericson and Fuster (2011), Rosato and Tymula (2019), that supports the model of Kőszegi and Rabin (2006). In constrast, our findings are not consistent with other research that challenges this behavior (Cerulli-Harms et al., 2019) or endorses alternative theories of distributional dependence (e.g., Isoni, 2011, Mazar et al., 2013, Smith, 2012, Wenner, 2015. ...
We explore several behavioral issues associated with bidding behavior in the Becker-DeGroot-Marschak (BDM) mechanism; a popular mechanism in experimental economics and valuation research. By manipulating the random binding price and framing, we find that bids are affected by the choices made by experimenters. Our theoretical framework, shows that the treatment effects are consistent with an attachment to expectations-based reference points, anchoring on the highest price, as well as the no-loss-in-buying hypothesis of Novemsky and Kahneman (2005). Overall, our theory and experimental results confirm that the mechanism is not incentive compatible and thus previous results regarding product valuations, as well as various treatment effects identified using the mechanism, should be interpreted as conditional on the particular choice of design variables.
... Despite the promise of the KR formulation of the reference point, tests of the theory have yielded mixed results (see, e.g., Smith, 2019; Ericson and Fuster, 2011;Heffetz and List, 2014;Cerulli-Harms et al., 2019;Abeler et al., 2011;Gneezy et al., 2017). While early experimental applications in exchange behavior and effort provision showed treatment effects in line with KR comparative statics, subsequent replications and extensions have shown more limited or contradictory effects. ...
... One group of subjects is assigned to Condition B, a baseline endowment effect condition, where they decide whether they would like to exchange their object for the alternative. Another group of subjects is assigned to Condition F, where they decide whether to exchange their object under a probabilistic forced exchange mechanism akin to Cerulli-Harms et al. (2019). With probability 0.5, regardless of their decision, exchange will be forced. ...
... Our results may help to reconcile conflicting results in the empirical study of the KR model (Ericson and Fuster, 2011;Heffetz and List, 2014;Cerulli-Harms et al., 2019) and follow naturally from the broad recognition of heterogeneity in gain-loss attitudes (Sprenger, 2015;Erev et al., 2008;Harinck et al., 2007;Nicolau, 2012;Sokol-Hessner et al., 2009;Knetsch and Wong, 2009;Chapman et al., 2017). If we are to recognize that loss aversion is not a universal trait, we must also recognize it as a confound of first-order importance for empirical tests of expectations-based reference dependence. ...
This project examines the role of heterogeneity in gain-loss attitudes for identifying models of expectations-based reference dependence (Koszegi and Rabin, 2006, 2007) (KR). Different gain-loss attitudes lead to different signs for KR comparative statics. Failure to account for the known heterogeneity in gain-loss attitudes is a central confounding factor challenging prior tests of the KR model conducted under the assumption of universal loss aversion. We document heterogeneous treatment effects over gain-loss types in both an initial experiment and an exact replication. Recognizing heterogeneity over types allows us to both recover the KR model’s central predictions, and account for inconsistency across prior empirical tests.
... However, not all experimental evidence supports the idea that expectations shape reference points. Cerulli-Harms et al. (2019) endowed participants with either a mug or money and exogenously varied the probability of forced exchange. The impact of variation in the probability of forced exchange on valuation was mixed and sensitive to small manipulations in experimental design. ...
We study the impact of endowments and expectations on reference point formation and measure the value of food safety certification in the context of fish trading on real markets in Nigeria. In our field experiment, consumers can trade a known food item for a novel food item that is superior in terms of food safety––or vice versa. Endowments matter for reference point formation, but we also document a reverse endowment effect for a subsample of respondents. The effect of expectations about future ownership is weak and mixed. While expectations seem to affect bidding behavior for subjects “trading up” to obtain the certified food product (a marginally significant effect), it does not affect bids for subjects “trading down” to give up this novel food item. Finally, willingness to pay for safety certified food is large for our respondents—our estimate of the premium is bounded between 37 and 53% of the price of conventional, uncertified food.
... Bell (1985); Loomes and Sugden (1986); Kőszegi and Rabin (2006)). However, the experimental tests of the model's key predictions are mixed (Marzilli Ericson & Fuster, 2011;Heffetz & List, 2014;Abeler et al., 2011;Gneezy et al., 2017) and Cerulli-Harms et al. (2019). Particularly, Heffetz (2018) found that reference points are "sunk-in (rather than merely lagged) beliefs", which means the expectation needs "some sense of internalization or getting used to" to form a salient reference point. ...
In this paper, we investigate how loss aversion affects people’s behavior in private litigation. We find that a loss-averse plaintiff demands a higher settlement for intermediate claims to maintain her threat to proceed to trial following rejection compared to a loss-neutral plaintiff. For larger claims, a loss-averse plaintiff demands a lower offer to increase the settlement probability as loss pains her extra in trial. We also investigate how various policies affect loss-averse litigants’ settlement decisions. Only a reduction in the asymmetry of information about trial odds uniformly leads to higher settlement rates.
... Furthermore, villages in rural Uganda are a small-scale societies and so the social effects of the second round are also relevant to the local context. 2 An alternative would have been to assign reference lotteries not only randomly (which we did) but also transparently, for instance by tossing a coin for a subject to see, as in the tests of reference-dependent preferences of Fuster (2011) , Heffetz andList (2014) and Goette et al. (2019) . However, this would have precluded pursuing our interest in the effect on behaviour of features of the decision interface-of naturally suggested courses of action. ...
Risky choices often have a natural starting-point. For example, insurance-type decisions concern reducing risk while investment-type decisions concern increasing it. A recent reference-dependent utility model predicts such references influence behaviour. Stochastic references act as endowments, with riskier references leading to riskier choices. We test this prediction in an identical choice set using a between-subject design in rural Uganda. Subjects are subtly assigned to one of three reference lotteries. On average, those with riskier endowments risk half a standard deviation more coins. We also consider the effect of introducing a new stochastic reference. In a within-subject second round, we test whether a social signal acts as a competing reference. In our experiment, information on peers’ choices is a stronger pull than the initial treatment effect. On average, subjects converge to the social signal by 0.37 for each unit of difference. Previous research focuses on the absence or presence of risk, allowing either the reference or prospect to be non-degenerate. Our results allow both to contain an element of risk, and show that the endowment effect can operate on the level of risk: risky choice is influenced by the riskiness of the reference.
... Our evidence rejects the idea that more experienced market participants exhibit the endowment effect anomaly more strongly. 6 See, for example,(Engelmann and Hollard, 2010;Ericson and Fuster, 2014;Goette et al., 2014;Heffetz and List, 2014;Song, 2015). ...
... Together, our results highlight the importance of expectation as reference point in both value and probability computations. It should be noted that reference-dependent preference is an active area of research in behavioral and experimental economics in which expectation-based models for reference-dependent preferences have been proposed [2,48,[67][68][69][70] and tested [61][62][63][71][72][73][74]. These models, including ours and in the work by Palminteri and colleagues [30], share the feature of expectations as reference point, but they also differ in some other key aspects, for example, the definition of expectation and how it is updated. ...
Many decisions rely on how we evaluate potential outcomes and estimate their corresponding probabilities of occurrence. Outcome evaluation is subjective because it requires consulting internal preferences and is sensitive to context. In contrast, probability estimation requires extracting statistics from the environment and therefore imposes unique challenges to the decision maker. Here, we show that probability estimation, like outcome evaluation, is subject to context effects that bias probability estimates away from other events present in the same context. However, unlike valuation, these context effects appeared to be scaled by estimated uncertainty, which is largest at intermediate probabilities. Blood-oxygen-level-dependent (BOLD) imaging showed that patterns of multivoxel activity in the dorsal anterior cingulate cortex (dACC), ventromedial prefrontal cortex (VMPFC), and intraparietal sulcus (IPS) predicted individual differences in context effects on probability estimates. These results establish VMPFC as the neurocomputational substrate shared between valuation and probability estimation and highlight the additional involvement of dACC and IPS that can be uniquely attributed to probability estimation. Because probability estimation is a required component of computational accounts from sensory inference to higher cognition, the context effects found here may affect a wide array of cognitive computations.
... Our evidence rejects the idea that more experienced market participants exhibit the endowment effect anomaly more strongly. 6 See, for example,(Engelmann and Hollard, 2010;Ericson and Fuster, 2014;Goette et al., 2014;Heffetz and List, 2014;Song, 2015). ...
Winners of randomly assigned initial public offering (IPO) lottery shares are significantly more likely to hold these shares than lottery losers 1, 6, and even 24 months after the random allocation. This effect persists in samples of wealthy and highly active investors, suggesting along with additional evidence that this type of "endowment effect" is not solely driven by portfolio inertia or wealth effects. The effect decreases as experience in the IPO market increases, but persists even for the most experienced investors. These results suggest that agents' preferences and/or beliefs about an asset are not independent of ownership, providing field evidence derived from the behavior of 1.5 million Indian stock investors which is in line with the large laboratory literature documenting endowment effects. We evaluate the extent to which prominent models of endowment effects and/or investor behavior can explain our results. A combination of inattention and non-standard preferences (realization utility) or non-standard beliefs (salience based probability distortions) appears most consistent with our findings.
... In another (working) investigation of expectation theory, Goette et al. (2014) argued that varying the probability of the ability to choose is not a sharp test of the theory. Instead, the authors varied the probability of a forced exchange. ...
Valuation gaps and exchange asymmetries (aka "endowment effects") are among the most widely studied phenomena in the field of behavioral economics. The purpose of this chapter is to present the current state of the social science literature related to observed reluctance to trade. Numerous theories have been proposed and only a few might be safe to rule out based on the evidence to date. The chapter begins by describing the standard model of preferences, which generally assumes that valuation is independent of ownership status, and then catalogs early findings that seem to suggest that ownership status influences valuation. Early research tested various potential explanations for observed reluctance to trade, and the results did not point to any one theory. Despite this, the literature gravitated toward a single theory — endowment theory, which assumes that preferences are reference-dependent and that individuals are averse to losses. With endowment theory on the rise, some went to work to investigate the conditions that might trigger loss aversion and those that might reduce its effects. Since the early 1990s, a number of alternative theories have been developed and tested by both economists and psychologists including substitution theory, expectation theory, preference uncertainty, mere-ownership theory, enhancement theory, subject misconceptions, and regret avoidance. The chapter walks through each proposed theory, cataloging the evidence for and against. While some theories have garnered more support from the data than others, no single theory yet deserves the title of leading theory. In addition, the phenomenon itself has proved too unstable to warrant general claims that valuations depend on ownership (or expectations over ownership) or that individuals are generally reluctant to trade. Given the current state of the literature, to make such claims is to misrepresent the full set of results. As this chapter makes clear, much more work is required to develop a theory or set of theories worthy of designation as the leading theory.
... We study a total of nine treatments as summarized in Table 1. 1. In related research, focusing on reference-dependent preferences in exchange experiments, a similar pattern of results can be found: although some studies are favorable of expectations-based reference points (Ericson and Fuster 2011), or at least consistent with it (Smith 2012;Heffetz and List 2014), other papers testing features more closely to the core of expectations-based reference points find clear violations of these predictions (Goette, Harms, and Sprenger 2014). and Asian (D1) correspond to experimenter's assessment of gender and ethnicity at the time of the experiment. ...
Theories of expectations-based reference-dependent preferences have provided a critical modeling innovation, incorporating a structured theory of the formation of reference points. An important prediction of these models is a monotone response in behavior to changes in expectations. To test such models we conduct a real-effort experiment manipulating expectations and examining consequences on effort provision. In contrast to the theory, we document substantial nonmonotonicities in the effort response to changing expectations. Our results provide some evidence on the limitations of expectations-based reference dependence. (JEL: D81, D84, D12, D03)
In this paper, we investigate market design for online gaming platforms. We ask what motivates people to continue participation—success or failure. Using data from an online chess platform, we find strong evidence of heterogeneous history-dependent stopping behavior. We identify two behavioral types of people: those who are more likely to stop playing after a loss and those who are more likely to stop playing after a win. We propose a behavioral dynamic choice model in which the utility from playing another game is directly affected by the previous game’s outcome. We estimate this time nonseparable preference model and conduct counterfactual analyses to study alternative market designs. A matching algorithm designed to leverage stopping behavior can substantially alter the length of play.
This paper was accepted by Yan Chen, behavioral economics and decision analysis.
Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2021.03628 .
Social reference points have been identified to be important determinants of individuals’ welfare. We investigate the consequences of social reference points for risk taking in a laboratory experiment. In the main treatments, risk-taking subjects observe the predetermined earnings of peer subjects when making a risky choice. We exogenously manipulate peers’ earnings and find a significant treatment effect: decision makers make less risk-averse choices in the case of larger peers’ earnings. The treatment effect is consistent with an application of prospect theory to social reference points and cannot be explained by reference points based on counterfactual information, anchoring, and experimenter demand effects. In additional analyses, we show that diminishing sensitivity seems to play an important role in subjects’ risky choices. We explore also whether inequity aversion and expectations-based reference points can account for our findings and conclude that they do not provide plausible alternative explanations for them.
This paper was accepted by Yan Chen, behavioral economics and decision analysis.
Funding: This research was financially supported by the Bonn Graduate School of Economics and the Center for Economics and Neuroscience in Bonn.
Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2023.4698 .
We study Dutch and first-price auctions with expectations-based loss-averse bidders and show that the strategic equivalence between these formats no longer holds. Intuitively, as the Dutch auction unfolds, a bidder becomes more optimistic about her chances of winning; this stronger “attachment” effect pushes her to bid more aggressively than in the first-price auction. Thus, Dutch auctions raise more revenue than first-price ones. Indeed, the Dutch auction raises the most revenue among standard auction formats. Our results imply that dynamic mechanisms that make bidders more optimistic raise more revenue, thereby rationalizing the use of descending-price mechanisms by sellers in the field.
This article analyzes pretrial bargaining between litigants with reference-dependent preferences. We build on Bebchuk (1984, “Litigation and Settlement under Imperfect Information,” 15 Rand Journal of Economics 404–15) and, motivated by empirical evidence, assume that the referent is based on expectations. We find that reference dependence on behalf of plaintiffs increases the settlement probability. The fact that preferences are reference-dependent meaningfully influences comparative statics predictions. In our extensions, we discuss the role of fee shifting, the effect of having the referent based on the status quo instead of on expectations, and risk aversion.
We examine errors in learning that arise when an agent who suffers attribution bias fails to account for her reference-dependent utility. Such an agent neglects how the sensation of elation or disappointment relative to expectations contributes to her overall utility, and wrongly attributes this component of her utility to the intrinsic value of an outcome. In a sequential-learning environment, this form of misattribution generates contrast effects in evaluations and induces a recency bias: the misattributor's beliefs over-weight recent experiences and under-weight earlier ones. In the long-run, a loss-averse misattributor will grow unduly pessimistic and undervalue prospects in proportion to their variability. Both the short and long-run properties of beliefs under misattribution suggest a tendency to abandon worthwhile prospects when learning from experience. We additionally show how misattribution introduces incentives for familiar forms of expectations management.
Dans cette thèse, nous nous intéressons à la prise de décision individuelle, dans un environnement risqué. Plus précisément, nous étudions l’effet de la taille de l’enjeu de loterie binaire, sur l’attitude des individus face au risque, et ce, pour différents niveaux de probabilités de gain.Dans un premier temps, nous avons étudié l’évolution du degré d’aversion au risque relatif, en fonction de l’augmentation du niveau d’enjeu de loteries. Nous avons mis en évidence que ce degré d’aversion augmente avec le niveau d’enjeu lorsque la probabilité de gain est faible, tandis qu’il reste constant pour les probabilités plus substantielles. Bien que ces résultats corroborent de récentes analyses en économie expérimentale, ils ne sont pas compatibles avec les modèles de décision existants. En effet, ce pattern comportemental semble remettre en question le principe de séparabilité des probabilités et des conséquences supposées par la plupart des modèles de décision.Dans un second temps, nous nous sommes intéressés à l’effet des enjeux antérieures sur la prise de risque subséquente. Nous avons mis en évidence que les comportements décisionnels sont fortement influencés par l’exposition antérieure, bien que les situations de choix soient fonctionnellement et explicitement indépendantes. Ces résultats s’inscrivent dans le modèle récemment proposé par Baucells, Kontek et Lewandowski (2018). Ce modèle suggère que la perception des conséquences d'une loterie est fonction du contexte, toutefois, il se différencie de la Prospect Theory puisqu’il suppose que, dans un contexte décisionnel donné, l’étendue des conséquences disponible sert de référentiel pour l’évaluation de l'ensemble des issues.A travers ces études, nous montrons que la perception des conséquences monétaires des loteries semble aisément manipulable et influence grandement les comportements décisionnels des agents.
This paper provides field evidence on how reference points adjust, a degree of freedom in reference-dependence models. Examining this in the context of cabdrivers’ daily labor-supply behavior, we ask how the within-day timing of earnings affects decisions. Drivers work less in response to higher accumulated income, with a strong effect for recent earnings that gradually diminishes for earlier earnings. We estimate a structural model in which drivers work toward a reference point that adjusts to deviations from expected earnings with a lag. This dynamic view of reference dependence reconciles conflicting “neoclassical” and “behavioral” interpretations of evidence on daily labor-supply decisions. (JEL J22, J31, L94)
What explains the mixed evidence from laboratory tests of Kőszegi and Rabin’s (2006 and later) model of expectations-based reference-dependent preferences? We investigate one hypothesis: to become (behavior-affecting) reference points, probability beliefs have to sink in—being merely lagged, as the theory requires, is not sufficient. Past experiments with conflicting findings exogenously endowed subjects with beliefs that were equally lagged, but possibly unequally sunk-in. In four experiments, whose designs replicate past KR-nonsupporting experiments, we add new sink-in manipulations that endow individuals with additional, visual/physical probability impressions. Our findings are more KR-supporting in an endowment-effect setting but not in an effort-provision setting.
Expectations-based reference dependence has been shown to be important across a variety of contexts in Psychology and Economics. Do expectations play a role in moral judgment? The higher our beliefs are relative to an outcome, do we punish more harshly? This paper reports a series of experiments investigating the hypothesis that expectations as reference points per se affect punishment. The experimental design varies the expectation the Punisher holds just before she learns what actually occurred. In tandem with the manipulation, expectations are shown to vary significantly and substantially. However, punishment does not respond to these exogenous changes in expectations. After 17 sessions, 295 Punishers, and six experimental setups, expectations are shown not to affect punishment in any systematic way.
Theories of reference-dependent preferences propose that individuals evaluate outcomes as gains or losses relative to a neutral reference point. We test for reference dependence in a large data set of marathon finishing times (n = 9,789,093). Models of reference-dependent preferences such as prospect theory predict bunching of finishing times at reference points. We provide visual and statistical evidence that round numbers (e.g., a four-hour marathon) serve as reference points in this environment and as a result produce significant bunching of performance at these round numbers. Bunching is driven by planning and adjustments in effort provision near the finish line and cannot be explained by explicit rewards (e.g., qualifying for the Boston Marathon), peer effects, or institutional features (e.g., pacesetters).
Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2417 .
This paper was accepted by John List, behavioral economics.
We study the properties of a profit-maximizing monopolist's optimal price distribution when selling to a loss-averse consumer, where (following Kőszegi and Rabin (2006)) we assume that the consumer's reference point is her recent rational expectations about the purchase. If it is close to costless for the consumer to observe the realized price of the product, then – in a pattern consistent with several recently documented facts regarding supermarket pricing – the monopolist chooses low and variable “sale” prices with some probability and a high and sticky “regular” price with the complementary probability. Realizing that she will buy at the sale prices and hence that she will purchase with positive probability, the consumer chooses to avoid the painful uncertainty in whether she will get the product by buying also at the regular price. If it is more costly for the consumer to observe the realized price, then – in a pattern consistent with the pricing behavior of some other retailers (e.g. movie theaters) – the monopolist chooses a sticky price and holds no sales. In this case, a sale is less tempting and hence less effective in generating an expectation to purchase with positive probability. We also show that ex-ante competition for loyal consumers leads to sticky pricing while ex-post competition leads to marginal-cost pricing, and discuss several other extensions of the model.
We modify the principal-agent model with moral hazard by assuming that the agent is expectation-based loss averse according to Koszegi and Rabin (2006, 2007). The optimal contract is a binary payment scheme even for a rich performance measure, where standard preferences predict a fully contingent contract. The logic is that, due to the stochastic reference point, increasing the number of different wages reduces the agent's expected utility without providing strong additional incentives. Moreover, for diminutive occurrence probabilities for all signals the agent is rewarded with the fixed bonus if his performance exceeds a certain threshold. (JEL D82, D86, J41, M52, M12)
A key open question for theories of reference-dependent preferences is: what determines the reference point? One candidate is expectations: what people expect could affect how they feel about what actually occurs. In a real-effort experiment, we manipulate the rational expectations of subjects and check whether this manipulation influences their effort provision. We find that effort provision is significantly different between treatments in the way predicted by models of expectation-based, reference-dependent preferences: if expectations are high, subjects work longer and earn more money than if expectations are low. (JEL D12, D84, J22)
Contrary to theoretical expectations, measures of willingness-to-accept greatly exceed measures of willingness-to-pay. This paper reports several experiments that demonstrate that this "endowment effect" persists even in market settings with opportunities to learn. Consumption objects (e.g., coffee mugs) are randomly given to half the subjects in an experiment. Markets for the mugs are then conducted. The Coase theorem predicts that about half the mugs will trade, but observed volume is always significantly less. When markets for "induced-value" tokens are conducted, the predicted volume is observed, suggesting that transactions costs cannot explain the undertrading for consumption goods. Copyright 1990 by University of Chicago Press.
We modify the Salop (1979) model of price competition with differentiated products by assuming that consumers are loss averse relative to a reference point given by their recent expectations about the purchase. Consumers' sensitivity to losses in money increases the price responsiveness of demand—and hence the intensity of competition—at higher relative to lower market prices, reducing or eliminating price variation both within and between products. When firms face common stochastic costs, in any symmetric equilibrium the markup is strictly decreasing in cost. Even when firms face different cost distributions, we identify conditions under which a focal-price equilibrium (where firms always charge the same "focal" price) exists, and conditions under which any equilibrium is focal. (JEL D11 , D43, D81, L13)
Isoni, Loomes, and Sugden (2011) assert that Plott and Zeiler (2005) reported inaccurate results. Placing ILS's selective quotes into context demonstrates otherwise. Additionally, examining the data closely yields three conclusions. First, all mug data reject endowment effect theory. Second, lottery gaps are associated with unstable attitudes toward uncertainty, a finding consistent with PZ's (2005) lottery data description, explicit warnings about procedure limitations and the data supplement, which reports the lottery data and cautions. Third, lottery outcome beliefs are influenced by whether WTP or WTA is reported, suggesting that changing beliefs, as opposed to the shape of preferences, produce lottery gaps. (JEL C91)
Systematic asymmetries in exchange behavior have been widely interpreted as support for "endowment effect theory," an application of prospect theory positing that loss aversion and utility function kinks set by entitlements explain observed asymmetries. We experimentally test an alternative explanation, namely, that asymmetries are explained by classical preference theories finding influence through the experimental procedures typically used. Contrary to the predictions of endowment effect theory, we observe no asymmetries when we modify procedures to remove the influence of classical preference theories. When we return to traditional-type procedures, however, the asymmetries reappear. The results support explanations based in classical preference theories and reject endowment effect theory. (JEL D01)
This paper presents evidence that loss aversion affects taxpayers as they file their annual tax returns, and presents a framework for estimating the policy impact of this psychological phenomenon. In my theoretical framework, taxpayers manipulate the money paid to the tax authority through avoidance and evasion activities. When taxpayers face the prospect of owing the tax authority money on tax day, loss aversion generates the perception of a greater marginal utility of tax reduction and therefore motivates greater pursuit of tax reduction activities. Applying a bunching-based identification strategy to U.S. tax return data, I estimate that taxpayers facing a payment on tax day reduce their tax liability by $34 more than taxpayers owed a refund.
We propose a model of job search with reference-dependent preferences, with loss aversion relative to recent income (the reference point). In this model, newly unemployed individuals search hard since consumption is below their reference point. Over time, though, they get used to lower income, and thus reduce their search effort. In anticipation of a benefit cut their search effort rises again, then declines once they get accustomed to the lower post-cut benefit level. The model fits the typical pattern of exit from unemployment, even with no unobserved heterogeneity. To distinguish between this and other models, we use a unique reform in the UI benefit path. In 2005, Hungary switched from a single-step UI system to a two-step system, with overall generosity unchanged. The system generated increased hazard rates in anticipation of, and especially following, benefit cuts in ways the standard model has a hard time explaining. We estimate a model with optimal consumption, endogenous search effort, and unobserved heterogeneity. The reference-dependent model fits the hazard rates substantially better than plausible versions of the standard model, including habit formation. Our estimates indicate a slow-adjusting reference point and substantial impatience, likely reflecting present-bias.
A hallmark result within behavioral economics is that individuals' choices are affected by current endowments. A recent theory due to Kőszegi and Rabin ( , Quarterly Journal of Economics, 121, 1133–1165) explains such endowment effect with a model of expectations-based reference-dependent preferences. Departing from past work, we conduct complementary experiments to disentangle expectations—verified probabilistic beliefs held by subjects—from other features of endowment—such as “assignment” to a good—hence allowing us to compare the effect of expectations with that of other variations. While mere assignment can affect choices, we do not find a large role in the effect for Kőszegi–Rabin expectations.
Theories of expectations-based reference-dependent preferences have provided a critical modeling innovation, incorporating a structured theory of the formation of reference points. An important prediction of these models is a monotone response in behavior to changes in expectations. To test such models we conduct a real-effort experiment manipulating expectations and examining consequences on effort provision. In contrast to the theory, we document substantial nonmonotonicities in the effort response to changing expectations. Our results provide some evidence on the limitations of expectations-based reference dependence. (JEL: D81, D84, D12, D03)
This study incorporates a recent preference specification of expectations-based loss aversion, which has been applied broadly in microeconomics, into a classic macro model to offer a unified explanation for three empirical observations about life-cycle consumption. First, loss aversion explains excess smoothness and sensitivity–that is, the empirical observation that consumption responds to income shocks with a lag. Intuitively, such lagged responses allow the agent to delay painful losses in consumption until his expectations have adjusted. Second, the preferences generate a hump-shaped consumption profile. Early in life, consumption is low due to a firstorder precautionary-savings motive. However, as uncertainty resolves over time, this motive is dominated by time-inconsistent overconsumption that eventually leads to declining consumption toward the end of life. Third, consumption drops at retirement. Prior to retirement, the agent wants to overconsume his uncertain income before his expectations catch up. Post-retirement, however, income is no longer uncertain, and overconsumption is associated with a sure loss in future consumption. As an empirical contribution, I structurally estimate the preference parameters using life-cycle consumption data. My estimates match those obtained in experiments and other micro studies, and generate the degree of excess smoothness observed in macro consumption data.
Another social science looks at itself
Experimental economists have joined the reproducibility discussion by replicating selected published experiments from two top-tier journals in economics. Camerer et al. found that two-thirds of the 18 studies examined yielded replicable estimates of effect size and direction. This proportion is somewhat lower than unaffiliated experts were willing to bet in an associated prediction market, but roughly in line with expectations from sample sizes and P values.
Science , this issue p. 1433
A hallmark result within behavioral economics is that individuals' choices are affected by current endowments. A recent theory due to Kőszegi and Rabin (, Quarterly Journal of Economics, 121, 1133–1165) explains such endowment effect with a model of expectations-based reference-dependent preferences. Departing from past work, we conduct complementary experiments to disentangle expectations—verified probabilistic beliefs held by subjects—from other features of endowment—such as “assignment” to a good—hence allowing us to compare the effect of expectations with that of other variations. While mere assignment can affect choices, we do not find a large role in the effect for Kőszegi–Rabin expectations.
This paper incorporates expectations-based reference-dependent preferences into the canonical Lucas-tree asset-pricing economy. Expectations-based loss aversion increases the equity premium and decreases the consumption-wealth ratio, because uncertain fluctuations in consumption are more painful. Moreover, because unexpected cuts in consumption are particularly painful, the agent wants to postpone such cuts to let his reference point decrease. Thus, even though shocks are i.i.d., loss aversion induces variation in the consumption-wealth ratio, which generates variation in the equity premium, expected returns, and predictability. The level and variation in the equity premium and the predictability in returns match historical moments, but the associated variation in intertemporal substitution motives results in excessive variation in the risk-free rate. This effect can be partially offset with variation in expected consumption growth, heteroskedasticity in consumption growth, or time-variant disaster risk. As a key contribution, I show that the preferences resolve the equity-premium puzzle and simultaneously imply plausible risk attitudes towards small and large wealth bets.
This study explores the implications of dissapointment, a psychological reaction caused by comparing the actual outcome of a lottery to one's prior expectations, for decision making under uncertainty. Explicit recognition that decision makers may be paying a premium to avoid potential disappointment provides an interpretation for some known behavioral paradoxes, and suggests that decision makers may be sensitive to the manner in which a lottery is resolved. The concept of disappointment is integrated into utility theory in a prescriptive model.
A central assumption of neoclassical economics is that reservation prices for familiar products express people’s true preferences for these products, that is, they represent the total benefit that a good confers to the consumers, and are thus, independent of actual prices in the market. Nevertheless, a vast amount of research has shown that valuations can be sensitive to other salient prices; particularly when individuals are explicitly anchored on them. In this paper, the authors extend previous research on single-price anchoring and study the sensitivity of valuations to the distribution of prices found for the product in the market. In addition, they examine its possible causes. They find that market-dependent valuations cannot be fully explained by rational inferences consumers draw about a product’s value, and are unlikely to be fully explained by true market-dependent preferences. Rather, the market dependence of valuations likely reflects consumers’ focus on something other than the total benefit that the product confers to them. Furthermore, this paper shows that market-dependent valuations persist when – as in many real-life settings – individuals make repeated purchase decisions over time and infer the distribution of the product’s prices from their market experience. Finally, the authors consider the implications of their findings for marketers and consumers.
The endowment effect has been widely documented. Recent models of reference-dependent preferences indicate that expectations play a prominent role in the presence of the phenomenon. A subset of such expectations-based models predicts an endowment effect for risk when reference points change from certain to stochastic. In two purposefully simple risk preference experiments, eliminat-ing often-discussed confounds, I demonstrate both between and within-subjects an endowment effect for risky gambles. While subjects are virtually risk neutral when choosing between fixed gambles and changing certain amounts, a high de-gree of risk aversion is displayed when choosing between fixed amounts and chang-ing gambles. These results provide needed separation between expectations-based reference-dependent models, allow for evaluation of recent theoretical ex-tensions, and may help to close a long-standing debate in decision science on inconsistency between probability and certainty equivalent methodology for util-ity elicitation.
We develop a rational dynamic model in which people are loss averse over changes in beliefs about present and future consumption. Because changes in wealth are news about future consumption, preferences over money are reference-dependent. If news resonates more when about imminent consumption than when about future consumption, a decision maker might (to generate pleasant surprises) overconsume early relative to the optimal committed plan, increase immediate consumption following surprise wealth increases, and delay decreasing consumption following surprise losses. Since higher wealth mitigates the effect of bad news, people exhibit an unambiguous first-order precautionary-savings motive. (JEL D14, D81, D83, D91)
While evidence suggests that people evaluate outcomes with respect to reference points, little is known about what determines them. We conduct two experiments that show that reference points are determined, at least in part, by expectations. In an exchange experiment, we endow subjects with an item and randomize the probability they will be allowed to trade. Subjects that are less likely to be able to trade are more likely to choose to keep their item. In a valuation experiment, we randomly assign subjects a high or low probability of obtaining an item and elicit their willingness-to-accept for it. The high probability treatment increases valuation of the item by 20--30%. Copyright 2011, Oxford University Press.
Aside from possible income effects, measures of the maximum amounts people will pay to avoid a loss and the minimum compensation
necessary for them to accept it are generally assumed to be equivalent. Unexpectedly wide variations between these sums, however,
have been noted in survey responses to hypothetical options. This paper reports the results of a series of experiments that
confronted people with actual money payments and cash compensations. The results indicate that the compensation measure of
value seems to exceed significantly the willingness to pay measure, which would appear to call into some question various
rules of entitlement, damage assessments, and interpretations of indifference curves.
Compensation schemes often reward success but do not penalize failure. Fixed salaries with stock options or bonuses have this feature. Yet the standard principal-agent model implies that pay is normally monotonically increasing in performance. This paper shows that, under loss aversion, there will be intervals over which pay is insensitive to performance, with the use of carrots but not sticks frequently optimal, especially when risk aversion is low and reference income is endogenous. A further benefit of capping losses, for example through options, is to discourage reckless behavior by executives seeking to resurrect their fortunes. (JEL:F3, F4) (c) 2007 by the European Economic Association.
In this paper we introduce the Online Recruitment System for Economic Experiments (ORSEE). With this software experimenters have a free, convenient and very powerful tool to organize their experiments and sessions in a standardized way. Additionally, ORSEE provides subject pool statistics, a laboratory calendar, and tools for scientific exchange. A test system has been installed in order to visually support the reader while reading the paper.
We use Koszegi and Rabin's (2006) model of reference-dependent utility, and an extension of it that applies to decisions with delayed consequences, to study preferences over monetary risk. Because our theory equates the reference point with recent probabilistic beliefs about outcomes, it predicts specific ways in which the environment influences attitudes toward modest-scale risk. It replicates "classical" prospect theory—including the prediction of distaste for insuring losses—when exposure to risk is a surprise, but implies first-order risk aversion when a risk, and the possibility of insuring it, are anticipated. A prior expectation to take on risk decreases aversion to both the anticipated and additional risk. For large-scale risk, the model allows for standard "consumption utility" to dominate reference-dependent "gain-loss utility," generating nearly identical risk aversion across situations. (JEL D81)
An axiomatic model of preferences over lotteries is developed. It is shown that this model is consistent with the Allais paradox, includes expected utility theory as a special case, and is only one parameter (" beta") richer than the expected utility model. Allais paradox type behavior is identified with positive values of "beta." Preferences with positive "beta" are said to be disappointment averse. It is shown that risk aversion implies disappointment aversion and that the Arrow-Pratt measures of risk aversion can be generalized in a straight-forward manner to the current framework. Copyright 1991 by The Econometric Society.
We develop a model of reference-dependent preferences and loss aversion where “gain-loss utility” is derived from standard
“consumption utility” and the reference point is determined endogenously by the economic environment. We assume that a person's
reference point is her rational expectations held in the recent past about outcomes, which are determined in a personal equilibrium by the requirement that they must be consistent with optimal behavior given expectations. In deterministic environments,
choices maximize consumption utility, but gain-loss utility influences behavior when there is uncertainty. Applying the model
to consumer behavior, we show that willingness to pay for a good is increasing in the expected probability of purchase and
in the expected prices conditional on purchase. In within-day labor-supply decisions, a worker is less likely to continue
work if income earned thus far is unexpectedly high, but more likely to show up as well as continue work if expected income
is high.
The central proposition of disappointment theory is that an individual forms expectations about uncertain prospects, and that
if the actual consequence turns out to be worse than (or better than) that expectation, the individual experiences a sensation
of disappointment (or elation) generating a decrement (or increment) of utility which modifies the basic utility derived from
the consequence. By incorporating a simple disappointment-elation function into a model of individual choice, many observed
violations of conventional expected utility axioms—including violations of Savage's sure-thing principle and the “isolation
effect”—can be predicted and defended as rational and dynamically consistent behaviour.