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Expectation-based loss aversion and strategic interaction

Simon Dato, Andreas Grunewald, Daniel Müller and Philipp Strack

Games and Economic Behavior, 2017, vol. 104, issue C, 681-705

Abstract: By extending the equilibrium concepts of Kőszegi and Rabin (2006, 2007), this paper analyzes the strategic interaction of expectation-based loss-averse players. For loss-averse players with choice-acclimating expectations, the utility from playing a mixed strategy is not linear but convex in the probabilities they assign to their pure strategies. As a consequence, they are generally unwilling to randomize and an equilibrium may fail to exist. For players with choice-unacclimating expectations, by contrast, randomizing over their pure strategies may indeed constitute a credible best response and an equilibrium always exists. Building upon these insights, we delineate how expectation-based loss-averse players differ in their strategic behavior from their counterparts with standard expected-utility preferences, derive novel strategic effects, discuss equilibrium selection, and derive equilibrium play for some simple games.

Keywords: Non-cooperative games; Expectation-based loss aversion; Reference-dependent preferences; Mixed strategies (search for similar items in EconPapers)
JEL-codes: C72 D01 D03 D81 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:gamebe:v:104:y:2017:i:c:p:681-705