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Loss Aversion Equilibrium

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Author Info
Jonathan Shalev (CORE)

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Abstract

The 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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Paper provided by EconWPA in its series Game Theory and Information with number 9703001.

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Length: 25 pages
Date of creation: 11 Mar 1997
Date of revision: 11 Mar 1997
Handle: RePEc:wpa:wuwpga:9703001

Note: Type of Document - LaTeX; pages: 25; figures: included. New updated version - comments welcome.
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Web page: http://129.3.20.41

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Related research
Keywords: loss aversion reference dependence equilibrium

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Find related papers by JEL classification:
C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  2. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1325-48, December. [Downloadable!] (restricted)
  3. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1991. "The Endowment Effect, Loss Aversion, and Status Quo Bias: Anomalies," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter. [Downloadable!] (restricted)
  4. Dekel, Eddie, 1986. "An axiomatic characterization of preferences under uncertainty: Weakening the independence axiom," Journal of Economic Theory, Elsevier, vol. 40(2), pages 304-318, December. [Downloadable!] (restricted)
  5. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March. [Downloadable!] (restricted)
  6. Ferreira J. -L. & Gilboa I. & Maschler M., 1995. "Credible Equilibria in Games with Utilities Changing during the Play," Games and Economic Behavior, Elsevier, vol. 10(2), pages 284-317, August. [Downloadable!] (restricted)
    Other versions:
  7. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May. [Downloadable!] (restricted)
  8. Kahneman, Daniel, 1992. "Reference points, anchors, norms, and mixed feelings," Organizational Behavior and Human Decision Processes, Elsevier, vol. 51(2), pages 296-312, March. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Botond Koszegi & Matthew Rabin, 2005. "A Model of Reference-Dependent Preferences," Levine's Bibliography 784828000000000341, UCLA Department of Economics. [Downloadable!]
  2. Jonathan Shalev, 1998. "Loss Aversion in Repeated Games," Game Theory and Information 9802005, EconWPA. [Downloadable!]
    Other versions:
  3. Philippe Jehiel & Oliver Compte, 2007. "Bargaining with Reference Dependent Preferences," Levine's Bibliography 122247000000001552, UCLA Department of Economics. [Downloadable!]
  4. Botond Koszegi & Matthew Rabin, 2006. "Reference-Dependent Risk Attitudes," Levine's Bibliography 122247000000001267, UCLA Department of Economics. [Downloadable!]
  5. Einat Neuman & Shoshana Neuman, 2007. "Reference-Dependent Preferences and Loss Aversion: A Discrete Choice Experiment in the Health-Care Sector," IZA Discussion Papers 3238, Institute for the Study of Labor (IZA). [Downloadable!]
  6. Andrea Patacconi & Florian Ederer, MIT, 2005. "Interpersonal Comparison, Status and Ambition in Organisations," Economics Series Working Papers 222, University of Oxford, Department of Economics. [Downloadable!]
  7. Astrid Matthey & Nadja Dwenger, 2008. "Don’t aim too high: the potential costs of high aspirations," SFB 649 Discussion Papers SFB649DP2008-011, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
    Other versions:
  8. David Gill & Rebecca Stone, 2006. "Fairness and Desert in Tournaments," Economics Series Working Papers 279, University of Oxford, Department of Economics. [Downloadable!]
  9. Han Bleichrodt & José María Abellán-Perpiñan & JoséLuis Pinto & Ildefonso Méndez-Martínez, 2005. "Resolving Inconsistencies in Utility Measurement under Risk: Tests of Generalizations of Expected Utility," Economics Working Papers 798, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
    Other versions:
  10. Audrey Hu & Liang Zou, 2008. "Auctions under Payoff Uncertainty: The Case with Heterogeneous Bidder-Aversion to Downside Risk," Tinbergen Institute Discussion Papers 08-044/1, Tinbergen Institute, revised 22 Apr 2008. [Downloadable!]
  11. Farah, N. & Satchell, S.E., 2003. "A Loss Aversion Performance Measure," Cambridge Working Papers in Economics 0333, Faculty of Economics, University of Cambridge. [Downloadable!]
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