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Chapter 10: A Test of the Theory of Reference-Dependent Preferences

Chapter 10: A Test of the Theory of Reference-Dependent Preferences

pp. 180-201

Authors

, University of East Anglia, , University of East Anglia, , University of East Anglia, , University of East Anglia, , University of East Anglia
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Summary

ABSTRACT. Eight alternative methods of eliciting preferences between money and a consumption good are identified: two of these are standard willingness-to-accept and willingness-to-pay measures. These methods differ with respect to the reference point used and the dimension in which responses are expressed. The loss aversion hypothesis of Tversky and Kahneman's theory of reference-dependent preferences predicts systematic differences between the preferences elicited by these methods. These predictions are tested by eliciting individuals' preferences for two private consumption goods; the experimental design is incentive-compatible and controls for income and substitution effects. The theory's predictions are broadly confirmed.

In conventional consumer theory each individual's choices are determined by a preference ordering over consumption bundles; this ordering is independent of the individual's endowment. However, a number of recent papers have suggested that preferences may be conditioned on current endowments, and that individuals are typically “loss averse”: for example, a person may prefer bundle x to bundle y if she is endowed with x, but prefer y to x if endowed with y. The most fully worked-out general theory of this kind is probably Tversky and Kahneman's [1991] theory of reference-dependent preferences. Tversky and Kahneman present their theory as an explanation of a body of preexisting evidence. In this paper we report a systematic experimental test of some of the implications of reference-dependent theory.

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