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Reference Point Formation Over Time: A Weighting Function Approach

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Author Info

  • Baucells, Manel

    ()
    (IESE Business School)

  • Weber, Martin

    ()
    (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)

  • Welfens, Frank

    ()
    (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)

Abstract

Although the concept of reference point dependent preferences has been adopted to almost all fields of behavioral economics, especially marketing and behavioral finance, we still know very little about how decision makers form their reference points given a sequence of prices. Our paper provides both a theoretical framework on reference point formation over time, based on cumulative prospect theory’s s-shaped weighting function, and a new experimental method for eliciting subjects’ individual reference points in a finance context. Consistent with our model, we document our subjects’ reference points to be best described by the first and the last price of the time series, with the equally weighted average and the highest price receiving smaller weights.. Results, however, vary strongly on the individual level and are also affected by the elicitation question applied.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 07-43.

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Length: 0 pages
Date of creation: 27 Jun 2007
Date of revision:
Handle: RePEc:xrs:sfbmaa:07-43

Note: Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.
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  1. Arkes, Hal & Hirshleifer, David & Jiang, Danling & Lim, Sonya, 2006. "Reference Point Adaptation: Tests in the Domain of Security Trading," MPRA Paper 4259, University Library of Munich, Germany.
  2. Camerer, Colin, et al, 1997. "Labor Supply of New York City Cabdrivers: One Day at a Time," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 407-41, May.
  3. David Bowman & Deborah Minehart & Matthew Rabin, 1994. "Loss aversion in a consumption/savings model," International Finance Discussion Papers 492, Board of Governors of the Federal Reserve System (U.S.).
  4. Philippe Jehiel & Oliver Compte, 2007. "Bargaining with Reference Dependent Preferences," Levine's Bibliography 122247000000001552, UCLA Department of Economics.
  5. Chip Heath & Steven Huddart & Mark Lang, 1999. "Psychological Factors And Stock Option Exercise," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 601-627, May.
  6. Bruno Jullien & Bernard Salanie, 2000. "Estimating Preferences under Risk: The Case of Racetrack Bettors," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 503-530, June.
  7. March, James G., 1988. "Variable risk preferences and adaptive aspirations," Journal of Economic Behavior & Organization, Elsevier, vol. 9(1), pages 5-24, January.
  8. Cook, Philip J & Clotfelter, Charles T, 1993. "The Peculiar Scale Economies of Lotto," American Economic Review, American Economic Association, vol. 83(3), pages 634-43, June.
  9. Kahneman, Daniel & Wakker, Peter P & Sarin, Rakesh, 1997. "Back to Bentham? Explorations of Experienced Utility," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 375-405, May.
  10. Andrea Frazzini, 2006. "The Disposition Effect and Underreaction to News," Journal of Finance, American Finance Association, vol. 61(4), pages 2017-2046, 08.
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Cited by:
  1. Schunk, Daniel, 2009. "Behavioral heterogeneity in dynamic search situations: Theory and experimental evidence," Journal of Economic Dynamics and Control, Elsevier, vol. 33(9), pages 1719-1738, September.
  2. Schunk, Daniel & Winter, Joachim, 2004. "The Relationship Between Risk Attitudes and Heuristics in Search Tasks: A Laboratory Experiment," Sonderforschungsbereich 504 Publications 04-23, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
  3. Lee, Carmen & Kräussl, Roman & Lucas, André & Paas, Leo, 2010. "Why do investors sell losers? How adaptation to losses affects future capitulation decisions," CFS Working Paper Series 2010/23, Center for Financial Studies (CFS).
  4. Carmen Lee & Roman Kraeussl & Andr� Lucas & Leonard J. Paas, 2008. "A Dynamic Model of Investor Decision-Making: How Adaptation to Losses affects Future Selling Decisions," Tinbergen Institute Discussion Papers 08-112/2, Tinbergen Institute, revised 02 Sep 2013.

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