Stochastic Reference Points And The Dependence Structure

Enrico De Giorgi (enrico.degiorgi@unisg.ch) and Thierry Post
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Thierry Post: Erasmus University Rotterdam

No 07-14, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This study develops a framework for dealing with stochastic reference points and endogenously selecting the reference point in reference-dependent choice theories that accounts for the joint probability distribution of the prospects and the reference point. Without accounting for the dependence structure, the endogenous reference point can deviate from the decision-maker’s optimum. Accounting for dependence, reference dependence affects choice behavior only if the reference point is (in part or in whole) exogenously fixed. In an application to well-known US investment benchmark data, investors invest in riskless T-bills rather than stocks if we ignore the dependence structure, while investing in small value stocks is optimal when we account for dependence.

Keywords: Reference-dependent preferences; loss aversion; prospect theory; dependence structure (search for similar items in EconPapers)
JEL-codes: C23 C91 C93 D81 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2007-02, Revised 2007-04
New Economics Papers: this item is included in nep-cbe, nep-exp and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp0714

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