Reference Dependence in Stochastic Choice
42 Pages Posted: 18 Jan 2016
Date Written: November 2015
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: Suggested Citation