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Reference-Point Formation and Updating

Manel Baucells (), Martin Weber and Frank Welfens ()
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Frank Welfens: Lehrstuhl fuer Bankbetriebslehre, Universitaet Mannheim, 68131 Mannheim, Germany

Management Science, 2011, vol. 57, issue 3, 506-519

Abstract: Reference-dependent preferences have been well accepted in decision sciences, experimental economics, behavioral finance, and marketing. However, we still know very little about how decision makers form and update their reference points given a sequence of information. Our paper provides some novel experiments in a financial context to advance the understanding of reference-point formation over time. Our subjects' reference price is best described as a combination of the first and the last price of the time series, with intermediate prices receiving smaller and nondecaying weights. Hence, reference prices are not recursive. We provide a parsimonious formula to predict the reference points, which we test out-of-sample. The fit of the model is reasonably good. This paper was accepted by George Wu, decision analysis.

Keywords: reference-point formation; reference-dependent preferences; disposition effect; probability weighting (search for similar items in EconPapers)
Date: 2011
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Handle: RePEc:inm:ormnsc:v:57:y:2011:i:3:p:506-519