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Loss Aversion Equilibrium

  • Jonathan Shalev

    (CORE)

The Nash equilibrium solution concept for 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 games to include loss aversion characteristics of the players. We define two types of loss-aversion equilibrium, a solution concept endogenizing reference points. The two types reflect different types of updating of reference points during the game. In equilibrium, reference points emerge as expressions of anticipation which are fulfilled. We show existence of myopic 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.

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Paper provided by EconWPA in its series Game Theory and Information with number 9703001.

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Length: 25 pages
Date of creation: 11 Mar 1997
Date of revision: 11 Mar 1997
Handle: RePEc:wpa:wuwpga:9703001
Note: Type of Document - LaTeX; pages: 25; figures: included. New updated version - comments welcome.
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1325-48, December.
  2. Dekel, Eddie, 1986. "An axiomatic characterization of preferences under uncertainty: Weakening the independence axiom," Journal of Economic Theory, Elsevier, vol. 40(2), pages 304-318, December.
  3. Jianakoplos, Nancy Ammon & Bernasek, Alexandra, 1998. "Are Women More Risk Averse?," Economic Inquiry, Western Economic Association International, vol. 36(4), pages 620-30, October.
  4. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
  5. J.L. Ferreira, 1992. "Credible Equilibria in Games with Utilities Changing During the Play," Discussion Papers 988, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
  7. Kahneman, Daniel, 1992. "Reference points, anchors, norms, and mixed feelings," Organizational Behavior and Human Decision Processes, Elsevier, vol. 51(2), pages 296-312, March.
  8. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
  9. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
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