Reference Point Formation Over Time: A Weighting Function Approach

Manel Baucells (), Martin Weber () and Frank Welfens ()
Additional contact information
Manel Baucells: IESE Business School, Postal: Avenida Pearson, 21; 08034 Barcelona; Spain
Martin Weber: Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre, Postal: L 5, 2, D-68131 Mannheim
Frank Welfens: Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre, Postal: L 5, 2, D-68131 Mannheim

No 07-43, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim

Abstract: 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.

Date: Written 2007-06-27
Note: Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.

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