Loss Aversion Equilibrium

Jonathan Shalev (jonathan.shalev@gmail.com)

Game Theory and Information from University Library of Munich, Germany

Abstract: The Nash equilibrium solution concept for games is based on the assumption of expected utility maximization. Reference dependent utility functions (in which utility is determined not only by an outcome, but also by the relationship of the outcome to a reference point) are a better predictor of behavior than expected utility. In particular, loss aversion is an important element of such utility functions. We extend games to include loss aversion characteristics of the players. We define two types of loss-aversion equilibrium, a solution concept endogenizing reference points. The two types reflect different types of updating of reference points during the game. In equilibrium, reference points emerge as expressions of anticipation which are fulfilled. We show existence of myopic loss-aversion equilibrium for any extended game, and compare it to Nash equilibrium. Comparative statics show that an increase in loss aversion of one player can affect his and other players' payoffs in different directions.

Keywords: loss aversion; reference dependence; equilibrium (search for similar items in EconPapers)
JEL-codes: C72 (search for similar items in EconPapers)
Pages: 25 pages
Date: 1997-03-11, Revised 1997-07-19
Note: Type of Document - LaTeX; pages: 25; figures: included. New updated version - comments welcome.
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Loss aversion equilibrium (2000)
Working Paper: Loss aversion equilibrium (2000)
Working Paper: Loss aversion equilibrium (1997)
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