Loss Aversion Equilibrium
AbstractThe Nash equilibrium solution concept for games is based on the assumption of expected utility maximization. Reference dependent utility functions (in which utility is determined not only by an outcome, but also by the relationship of the outcome to a reference point) are a better predictor of behavior than expected utility. In particular, loss aversion is an important element of such utility functions. We extend games to include loss aversion characteristics of the players. We define two types of loss-aversion equilibrium, a solution concept endogenizing reference points. The two types reflect different types of updating of reference points during the game. In equilibrium, reference points emerge as expressions of anticipation which are fulfilled. We show existence of myopic loss-aversion equilibrium for any extended game, and compare it to Nash equilibrium. Comparative statics show that an increase in loss aversion of one player can affect his and other players' payoffs in different directions.
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Bibliographic InfoPaper provided by EconWPA in its series Game Theory and Information with number 9703001.
Length: 25 pages
Date of creation: 11 Mar 1997
Date of revision: 11 Mar 1997
Note: Type of Document - LaTeX; pages: 25; figures: included. New updated version - comments welcome.
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loss aversion; reference dependence; equilibrium;
Other versions of this item:
- SHALEV, Jonathan, . "Loss aversion equilibrium," CORE Discussion Papers RP -1456, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- SHALEV, Jonathan, 1997. "Loss aversion equilibrium," CORE Discussion Papers 1997023, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
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