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Randomizing Endowments: An Experimental Study of Rational Expectations and Reference-Dependent Preferences

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Listed:
  • Götte, Lorenz

    (University of Bonn)

  • Cerulli-Harms, Annette

    (London Economics)

  • Sprenger, Charles

    (Stanford University)

Abstract

An important advance in the study of reference-dependent preferences is the discipline provided by coherent accounts of reference point formation. K?szegi and Rabin (2006) provide such discipline by positing a reference point grounded in rational expectations. We examine the predictions of K?szegi and Rabin (2006) in the context of market experiments with probabilistic forced exchange. The experiment tightly tests the predictions of K?szegi and Rabin (2006), as when the probability of forced exchange increases, individuals should grow more willing to exchange. This mechanism has the theoretical potential to eliminate and even reverse the 'endowment effect' (Knetsch and Sinden, 1984; Knetsch, 1989; Kahneman et al., 1990). Our results uniformly reject these theoretical predictions. In a series of experiments with a total of 930 subjects, sellers' valuations exceed buyers' valuations under all probabilities of forced exchange. In robustness tests where attention is drawn specifically to the forced exchange mechanism, the results are directionally more promising for buyers, but still reject the main thrust of the theoretical predictions. Our findings suggest a potential path forward incorporating failures to completely forecast sensations of gain and loss into models of expectations-based reference dependence.

Suggested Citation

  • Götte, Lorenz & Cerulli-Harms, Annette & Sprenger, Charles, 2014. "Randomizing Endowments: An Experimental Study of Rational Expectations and Reference-Dependent Preferences," IZA Discussion Papers 8639, Institute of Labor Economics (IZA).
  • Handle: RePEc:iza:izadps:dp8639
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    Cited by:

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    4. Oliver März, 2016. "Framing, Expectations and Reference Points," Working Papers ECARES ECARES 2016-40, ULB -- Universite Libre de Bruxelles.
    5. Dutcher, E. Glenn & Balafoutas, Loukas & Lindner, Florian & Ryvkin, Dmitry & Sutter, Matthias, 2015. "Strive to be first or avoid being last: An experiment on relative performance incentives," Games and Economic Behavior, Elsevier, vol. 94(C), pages 39-56.

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    More about this item

    Keywords

    reference-dependent preferences; rational expectations; personal equilibrium; endowment effect; expectations-based reference points;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles

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