Poverty, Vulnerability, and Reference-Dependent Utility

The numerous proposed measures of multi-period poverty and vulnerability have until now not taken into account the insights from behavioral economics. In this paper we argue that recent evidence on individuals' decision making is of high relevance for the measurement of poverty when switching from a static and certain to a dynamic and uncertain framework. Building on reference-dependent utility we propose new measures of both (perceived) multi-period poverty and vulnerability, where the poverty status of an individual is a function not only of (expected) consumption levels but also of (expected) losses and gains in consumption. We demonstrate the implications of the proposed measures with a small illustrative example.