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Loss aversion equilibrium

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  • SHALEV, Jonathan

    (Center for Operations Research and Econometrics (CORE), Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

Abstract

The Nash equilibrium solution concept for strategic form 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 strategic form games to include loss aversion characteristics of the players. We define loss-aversion equilibrium, a solution concept endogenizing reference points. Reference points emerge as expressions of anticipation which are fulfilled in equilibrium. We show existence of 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.

Suggested Citation

  • SHALEV, Jonathan, 1997. "Loss aversion equilibrium," LIDAM Discussion Papers CORE 1997023, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    • Handle: RePEc:cor:louvco:1997023
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    References listed on IDEAS

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    More about this item

    Keywords

    loss aversion; reference dependence; equilibrium;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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