Loss aversion with a state-dependent reference point
This study investigates loss aversion when the reference point is a state-dependent random variable. This case describes, for example, a money manager being evaluated relative to a risky benchmark index rather than a fixed target return level. Using a state-dependent structure, prospects are more (less) attractive if they depend positively (negatively) on the reference point. In addition, the structure avoids an inherent aversion to risky prospects and yields no losses when the prospect and the reference point are the same. Related to this, the optimal reference-dependent solution equals the optimal consumption solution (no loss aversion) when the reference point is selected completely endogenously. Given that loss aversion is widespread, we conclude that the reference point generally includes an important exogenously fixed component. For example, the typical investment benchmark index is externally fixed by the investment principal for the duration of the investment mandate. We develop a choice model where adjustment costs cause stickiness relative to an initial exogenous reference point.
|Date of creation:||Jul 2010|
|Date of revision:|
|Contact details of provider:|| Postal: Dufourstrasse 50, CH - 9000 St.Gallen|
Phone: +41 71 224 23 25
Fax: +41 71 224 31 35
Web page: http://www.seps.unisg.ch/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jonathan Shalev, 2000.
"Loss aversion equilibrium,"
International Journal of Game Theory,
Springer, vol. 29(2), pages 269-287.
- SHALEV, Jonathan, 1997. "Loss aversion equilibrium," CORE Discussion Papers 1997023, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- SHALEV, Jonathan, . "Loss aversion equilibrium," CORE Discussion Papers RP 1456, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Jonathan Shalev, 1997. "Loss Aversion Equilibrium," Game Theory and Information 9703001, EconWPA, revised 11 Mar 1997.
- Schmidt, Ulrich & Starmer, Chris & Sugden, Robert, 2008.
"Third-generation prospect theory,"
Open Access Publications from Kiel Institute for the World Economy
28932, Kiel Institute for the World Economy (IfW).
- Sugden, Robert, 2003. "Reference-dependent subjective expected utility," Journal of Economic Theory, Elsevier, vol. 111(2), pages 172-191, August.
- Christofides, Tasos C. & Vaggelatou, Eutichia, 2004. "A connection between supermodular ordering and positive/negative association," Journal of Multivariate Analysis, Elsevier, vol. 88(1), pages 138-151, January.
- Kahneman, Daniel & Tversky, Amos, 1979.
"Prospect Theory: An Analysis of Decision under Risk,"
Econometric Society, vol. 47(2), pages 263-91, March.
- Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
When requesting a correction, please mention this item's handle: RePEc:usg:dp2010:2010-23. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Martina Flockerzi)
If references are entirely missing, you can add them using this form.