Schedule - Parallel Session 6 - Reference-Dependence

Since the publication of the seminal paper of Kahneman and Tversky (1979), loss aversion has become one of the most important concepts in behavioral economics. Loss aversion refers to the tendency for individuals to strongly prefer avoiding losses than acquiring gains. Put differently, individuals seem to interpret outcomes as gains and losses relative to a reference point and to weight losses substantially more than objectively equal gains. Loss aversion has been widely documented. Many pieces of work have presented empirical evidence for loss aversion (Kahneman et al., 1990, and Tversky and Kahneman, 1991). Loss aversion has the strong feature of explaining many anomalies of choice under risk. Particularly, loss aversion is widely accepted as the cause (or the explanation) of the willingness to accept-willingness to pay gap (WTA-WTP gap). The WTA-WTP gap is the tendency to price substantially more an object as a seller than as a buyer. The WTA-WTP gap was a central topic in the last forty years and was extensively examined and replicated (Horowitz and McConnell, 2002). Recently, a debate confronting Plott and Zeiler, PZ, (Plott and Zeiler, 2005, and Plott and Zeiler, 2011) and Isoni, Loomes, and Sugden, ILS, (Isoni et al., 2011) stresses whether WTA-WTP gap is exclusively due to misconception. While PZ argue that the gap vanishes when misconception is removed, concluding that loss aversion has nothing to do with the observed gap, ISL demonstrate that the gap survive to control of misconception, without favoring any explanation of the gap. This study examines the part of loss aversion in explaining the observed gap between WTA and WTP after controlling for misconception. The approach of this study is as follows; if the WTA-WTP gap results from endowment effect, than loss-averse subjects will exhibit such gap while non-loss averse subject will not. The key point is thus to classify subjects according to their loss aversion. For each subject, (1) we replicate PZ procedure to measure WTA-WTP gap and control for misconception and (2) we elicit loss aversion parameter. Under the hypothesis that WTA-WTP gap is not only due to misconception, we should observe a positive correlation between WTA-WTP measure and loss aversion measure.

This paper uses several controlled laboratory experiments to accomplish three objectives. First, I test to what extent lagged expectations and the status quo determine the reference point based on different theoretical implications. I explicitly manipulated expectations by exogenously varying the fluctuations of lagged beliefs and tested whether expectations affect risk attitudes. For the control group, I send an email that said they would receive a fixed payment for the experiment ($10). For the treatment groups, the email said that they would receive payment through a lottery (1/3 chance to receive $10, 1/3 chance to receive $15, and 1/3 chance to receive $20). When the subjects were in the lab, the lottery resolved and then those in the treatment groups ascertain whether they would receive $10, $15, or $20. Then both groups would answer risk-attitude questions to elicit their risk attitudes. I find that those who are treated to expect higher payoff are significantly less risk averse. These results suggest that both lagged expectations and the status quo influence the reference point significantly. Second, I exogenously varied the time of receiving new information and tested whether individuals assimilated new information into their reference points, and if so, at what rate. I randomly split the overall treatment group into two groups: the ‘no-waiting’ treatment group and the ‘waiting’ treatment group. I elicit the risk attitude of the ‘no-waiting’ group immediately after they discovered the realization of the lottery. The ‘waiting’ group filled out a survey about their social economic background after they knew the realization of the lottery, and then – after a few minutes – answered the risk attitude questions. I find that those in the waiting group are more risk averse than no-waiting group. These results suggest that while reference points are sticky to lagged expectations, subjects adjust their reference points quickly after receiving new information, which further confirms the role of expectation as the reference point Finally, I derive new theoretical predictions from the model with fixed reference points and that with stochastic reference points. The model with fixed reference points predicts that increase in expectation of higher payoff in a certain range does not change the risk attitudes. In contrast, the model with stochastic reference points predicts that the increase in the same range will make individuals less risk averse. I then manipulate the expectation within the range that distinguishes these two expectations-based reference-dependent models. I find that increase the expectation of higher payoff make individuals less risk averse, supporting the stochastic reference point model. Moreover, structural estimation also support the model of the stochastic reference point reflecting full distribution of expected outcomes rather than that with a fixed reference point.