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Reference Point Formation Over Time: A Weighting Function Approach

  • Baucells, Manel

    ()

    (IESE Business School)

  • Weber, Martin

    ()

    (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)

  • Welfens, Frank

    ()

    (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)

Although the concept of reference point dependent preferences has been adopted to almost all fields of behavioral economics, especially marketing and behavioral finance, we still know very little about how decision makers form their reference points given a sequence of prices. Our paper provides both a theoretical framework on reference point formation over time, based on cumulative prospect theory’s s-shaped weighting function, and a new experimental method for eliciting subjects’ individual reference points in a finance context. Consistent with our model, we document our subjects’ reference points to be best described by the first and the last price of the time series, with the equally weighted average and the highest price receiving smaller weights.. Results, however, vary strongly on the individual level and are also affected by the elicitation question applied.

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Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 07-43.

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Length: 0 pages
Date of creation: 27 Jun 2007
Date of revision:
Handle: RePEc:xrs:sfbmaa:07-43
Note: Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.
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  1. Bruno Jullien & Bernard Salanié, 1997. "Estimating Preferences under Risk : The Case of Racetrack Bettors," Working Papers 97-39, Centre de Recherche en Economie et Statistique.
  2. Andrea Frazzini, 2006. "The Disposition Effect and Underreaction to News," Journal of Finance, American Finance Association, vol. 61(4), pages 2017-2046, 08.
  3. Bowman, David & Minehart, Deborah & Rabin, Matthew, 1999. "Loss aversion in a consumption-savings model," Journal of Economic Behavior & Organization, Elsevier, vol. 38(2), pages 155-178, February.
  4. March, James G., 1988. "Variable risk preferences and adaptive aspirations," Journal of Economic Behavior & Organization, Elsevier, vol. 9(1), pages 5-24, January.
  5. Arkes, Hal & Hirshleifer, David & Jiang, Danling & Lim, Sonya, 2006. "Reference Point Adaptation: Tests in the Domain of Security Trading," MPRA Paper 4259, University Library of Munich, Germany.
  6. Philippe Jehiel & Oliver Compte, 2007. "Bargaining with Reference Dependent Preferences," Levine's Bibliography 122247000000001552, UCLA Department of Economics.
  7. Camerer, Colin, et al, 1997. "Labor Supply of New York City Cabdrivers: One Day at a Time," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 407-41, May.
  8. Philip J. Cook & Charles T. Clotfelter, 1991. "The Peculiar Scale Economies of Lotto," NBER Working Papers 3766, National Bureau of Economic Research, Inc.
  9. Kahneman, Daniel & Wakker, Peter P & Sarin, Rakesh, 1997. "Back to Bentham? Explorations of Experienced Utility," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 375-405, May.
  10. Chip Heath & Steven Huddart & Mark Lang, 1999. "Psychological Factors And Stock Option Exercise," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 601-627, May.
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