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Loss Aversion and Bargaining

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  • Jonathan Shalev

Abstract

We consider bargaining situations where two players evaluate outcomes with reference-dependent utility functions, analyzing the effect of differing levels of loss aversion on bargaining outcomes. We find that as with risk aversion, increasing loss aversion for a player leads to worse outcomes for that player in bargaining situations. An extension of Nash’s axioms is used to define a solution for bargaining problems with exogenous reference points. Using this solution concept we endogenize the reference points into the model and find a unique solution giving reference points and outcomes that satisfy two reasonable properties, which we predict would be observed in a steady state. The resulting solution also emerges in two other approaches, a strategic (non-cooperative) approach using Rubinstein’s alternating offers model and a dynamic approach in which we find that even under weak assumptions, outcomes and reference points converge to the steady state solution from any non-equilibrium state.
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Suggested Citation

  • Jonathan Shalev, 2002. "Loss Aversion and Bargaining," Theory and Decision, Springer, vol. 52(3), pages 201-232, May.
    • Handle: RePEc:kap:theord:v:52:y:2002:i:3:p:201-232
    DOI: 10.1023/A:1019674323804
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    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory

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