Reference Dependence in Stochastic Choice

42 Pages Posted: 18 Jan 2016

See all articles by Soo Hong Chew

Soo Hong Chew

National University of Singapore; National University of Singapore; HKUST

Qiang Shen

Zhejiang University

Songfa Zhong

National University of Singapore (NUS) - Department of Economics

Date Written: November 2015

Abstract

While reference dependence has been widely observed in a deterministic choice setting, little is known about the nature of reference dependence in stochastic choice. We study stochastic choice in the setting of the elicitation of certainty equivalents where subjects often exhibit multiple-switching behavior when choosing between a lottery and a range of sure amounts. In our experiment, we observe a hump pattern in multiple-switching behavior -- the frequencies of multiple-switching behavior for gain and loss oriented lotteries are similar and are each significantly lower than that for mixed lotteries. Moreover, the observed hump pattern remains robust after controlling for risk attitude, response time, cognitive ability, and violation of first-order stochastic dominance. To account for the observed hump pattern in multiple-switching behavior, we discuss how to incorporate reference dependence into cumulative prospect theory from the perspectives of both deliberate randomization and random utility.

Keywords: stochastic choice, reference dependence, prospect theory, deliberate randomization, random utility, experiment

JEL Classification: C91, D81

Suggested Citation

Chew, Soo Hong and Shen, Qiang and Zhong, Songfa, Reference Dependence in Stochastic Choice (November 2015). Available at SSRN: https://ssrn.com/abstract=2717477 or http://dx.doi.org/10.2139/ssrn.2717477

Soo Hong Chew

National University of Singapore ( email )

1 Arts Link, AS2 #06-02
Singapore 117570, Singapore 119077
Singapore

National University of Singapore ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

HKUST ( email )

Clear Water Bay
Kowloon, Hong Kong
China

Qiang Shen

Zhejiang University

38 Zheda Road
Hangzhou, Zhejiang 310058
China

Songfa Zhong (Contact Author)

National University of Singapore (NUS) - Department of Economics ( email )

1 Arts Link, AS2 #06-02
Singapore 117570, Singapore 119077
Singapore

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