Stochastic Reference Points And The Dependence Structure
AbstractThis study develops a framework for dealing with stochastic reference points and endogenously selecting the reference point in reference-dependent choice theories that accounts for the joint probability distribution of the prospects and the reference point. Without accounting for the dependence structure, the endogenous reference point can deviate from the decision-maker’s optimum. Accounting for dependence, reference dependence affects choice behavior only if the reference point is (in part or in whole) exogenously fixed. In an application to well-known US investment benchmark data, investors invest in riskless T-bills rather than stocks if we ignore the dependence structure, while investing in small value stocks is optimal when we account for dependence.
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Bibliographic InfoPaper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 07-14.
Length: 23 pages
Date of creation: Feb 2007
Date of revision: Apr 2007
Reference-dependent preferences; loss aversion; prospect theory; dependence structure;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- C93 - Mathematical and Quantitative Methods - - Design of Experiments - - - Field Experiments
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-10-20 (All new papers)
- NEP-CBE-2007-10-20 (Cognitive & Behavioural Economics)
- NEP-EXP-2007-10-20 (Experimental Economics)
- NEP-UPT-2007-10-20 (Utility Models & Prospect Theory)
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