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Reference-Point Formation and Updating

Author

Listed:
  • Manel Baucells

    (Department of Economics and Business, Universitat Pompeu Fabra, 08005 Barcelona, Spain)

  • Martin Weber

    (Lehrstuhl fuer Bankbetriebslehre, Universitaet Mannheim, 68131 Mannheim, Germany; and Centre for Economic Policy Research, London EC1V 3PZ, United Kingdom)

  • Frank Welfens

    (Lehrstuhl fuer Bankbetriebslehre, Universitaet Mannheim, 68131 Mannheim, Germany)

Abstract

Reference-dependent preferences have been well accepted in decision sciences, experimental economics, behavioral finance, and marketing. However, we still know very little about how decision makers form and update their reference points given a sequence of information. Our paper provides some novel experiments in a financial context to advance the understanding of reference-point formation over time. Our subjects' reference price is best described as a combination of the first and the last price of the time series, with intermediate prices receiving smaller and nondecaying weights. Hence, reference prices are not recursive. We provide a parsimonious formula to predict the reference points, which we test out-of-sample. The fit of the model is reasonably good. This paper was accepted by George Wu, decision analysis.

Suggested Citation

  • Manel Baucells & Martin Weber & Frank Welfens, 2011. "Reference-Point Formation and Updating," Management Science, INFORMS, vol. 57(3), pages 506-519, March.
    • Handle: RePEc:inm:ormnsc:v:57:y:2011:i:3:p:506-519
    DOI: 10.1287/mnsc.1100.1286
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    References listed on IDEAS

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