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Author: Michaela Pagel
Publisher:
ISBN:
Category :
Languages : en
Pages : 50
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Book Description
This paper incorporates expectations-based reference-dependent preferences into the canonical Lucas-tree asset-pricing economy. Expectations-based loss aversion increases the equity premium and decreases the consumption-wealth ratio, because uncertain fluctuations in consumption are more painful. Moreover, because unexpected cuts in consumption are particularly painful, the agent wants to postpone such cuts to let his reference point decrease. Thus, even though shocks are i.i.d., loss aversion induces variation in the consumption-wealth ratio, which generates variation in the equity premium, expected returns, and predictability. The level and variation in the equity premium and the predictability in returns match historical moments, but the associated variation in intertemporal substitution motives results in excessive variation in the risk-free rate. This effect can be partially offset with variation in expected consumption growth, heteroskedasticity in consumption growth, or time-variant disaster risk. As a key contribution, I show that the preferences resolve the equity-premium puzzle and simultaneously imply plausible risk attitudes towards small and large wealth bets.
Author: Michaela Pagel
Publisher:
ISBN:
Category :
Languages : en
Pages : 50
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Book Description
This paper incorporates expectations-based reference-dependent preferences into the canonical Lucas-tree asset-pricing economy. Expectations-based loss aversion increases the equity premium and decreases the consumption-wealth ratio, because uncertain fluctuations in consumption are more painful. Moreover, because unexpected cuts in consumption are particularly painful, the agent wants to postpone such cuts to let his reference point decrease. Thus, even though shocks are i.i.d., loss aversion induces variation in the consumption-wealth ratio, which generates variation in the equity premium, expected returns, and predictability. The level and variation in the equity premium and the predictability in returns match historical moments, but the associated variation in intertemporal substitution motives results in excessive variation in the risk-free rate. This effect can be partially offset with variation in expected consumption growth, heteroskedasticity in consumption growth, or time-variant disaster risk. As a key contribution, I show that the preferences resolve the equity-premium puzzle and simultaneously imply plausible risk attitudes towards small and large wealth bets.
Author: A. Banerji
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
Author: Michaela Pagel
Publisher:
ISBN:
Category :
Languages : en
Pages : 70
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Book Description
I incorporate expectations-based reference-dependent preferences into a dynamic stochastic model to explain three major life-cycle consumption facts; the intuitions behind these three implications constitute novel connections between recent advances in behavioral economics and prominent ideas in the macro consumption literature. First, expectations-based loss aversion rationalizes excess smoothness and sensitivity in consumption, the puzzling empirical observation of lagged consumption responses to income shocks. Intuitively, in the event of an adverse shock, the agent delays painful cuts in consumption to allow his reference point to decrease. Second, the preferences generate a hump-shaped consumption profile. Early in life, consumption is low due to a first-order precautionary-savings motive, but as uncertainty resolves, this motive is dominated by time-inconsistent overconsumption, forcing consumption to decline toward the end of life. Third, consumption drops at retirement. When uncertainty is absent, the agent does not overconsume because he dislikes the associated certain loss in future consumption. Additionally, I obtain several new predictions about consumption; compare the preferences with habit formation, hyperbolic discounting, and temptation disutility; and structurally estimate the preference parameters.
Author: Robert Rutledge
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ISBN:
Category :
Languages : en
Pages :
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Book Description
We experimentally test Kőszegi and Rabin's (2006, 2007) theory of reference-dependent preferences in the context of price expectations. In an incentivised valuation task, participants are endowed with a mug and provide their willingness to accept (WTA) to sell it. We manipulate the sale price in a separate, exogenous forced sale scenario, which is predicted to produce a 'comparison effect', moving WTA in the opposite direction to the forced sale price. Consistent with the theory, we observe a treatment effect of between AUD $0.79 and $2.06 in the hypothesised direction; however, it is statistically insignificant. We also elicit participants' loss aversion to account for heterogeneity in the theorised effect; however, controlling for the interaction between our treatment and loss aversion does not consistently strengthen our result.
Author: Berber Kramer
Publisher:
ISBN:
Category :
Languages : en
Pages : 49
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A large body of literature suggests that consumers derive utility from gains and losses relative to a reference point. This paper shows that such reference dependence can affect savings in opposite directions depending on whether people face liquidity constraints. Existing models for wealth and intertemporal choice predict that reference dependence reduces savings but these models abstract from liquidity constraints. Introducing a liquidity constraint, I find that reference dependence can increase optimal savings for people without access to credit. Ex-post, after reference points have been formed, liquidity constraints force consumers to take part of an income loss in early periods, inducing those who are reference dependent to concentrate the full loss in early periods and save in order to eliminate future losses. Further, anticipating a liquidity constraint raises the expected level of future consumption and thus the expectations-based reference point for future periods, creating an ex-ante savings motive. These findings underscore that it is important to account for financial market imperfections when applying or testing reference-dependent models in low-income settings, and potentially explain heterogeneity in how much the poor save when facing binding liquidity constraints.
Author: Guofang Huang
Publisher:
ISBN:
Category :
Languages : en
Pages : 59
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Book Description
This paper empirically tests the expectations-based reference-dependent preference theory, by using a unique panel data-set on the non-negotiable daily list prices for used cars advertised by a large national dealership. It identifies a major point in car buyers' price expectation for a used car as the car's list price on the previous day. The paper finds that-- controlling for a car's actual price, its detailed attributes, the competitive environment and a rich set of fixed effects --a positive (negative) deviation of the car's actual from the previous day's list price lowers (increases) its daily sale probability significantly more than what can be accounted for by the standard effect of the car's resulting actual price. The additional tests that the paper conducts suggest that the car buyer's price expectation, not the identified major price point in the car buyer's price expectation, is the reference point that lead to the estimated reference-price effects. Unobserved stockpiling by consumers, a major confounding factor for most estimated reference-price effects, does not confound the paper's test.
Author: Justin Buffat
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ISBN:
Category :
Languages : en
Pages : 48
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Book Description
We build on Köszegi and Rabin (2009) and propose a model in which the reference point consists of two periods lagged beliefs about consumption outcomes. As opposed to the original model in which the reference point instantaneously adjusts to new information, our formulation renders the reference point somewhat sticky and allows sensations of gain and losses to persist for more than one period. Using a controlled experiment, we assess the relative importance of t-1 lagged beliefs with respect to t-2 lagged beliefs. Our results suggest that the speed of adjustment of the reference point might depend on the size of the stakes at play. Under low stakes, subjects remain unaffected by our manipulation. We interpret this result as evidence of a very fast adjustment of the reference point. A follow-up study in which the stakes are multiplied threefold documents a context-dependent house money effect, a phenomenon which can be rationalized by multiple-lagged beliefs reference-dependent preferences. Overall, our results help understanding the conditions under which past beliefs and emotions should be expected to linger and to affect subsequent behavior.
Author: Keith M. Marzilli Ericson
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ISBN:
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Languages : en
Pages : 0
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Evidence on loss aversion and the endowment effect suggests that people evaluate outcomes with respect to a reference point. Yet little is known about what determines reference points. We conduct two experiments that show that reference points are determined by expectations. In the first experiment, we endow subjects with an item and randomize the probability they will be allowed to trade it for an alternative. Subjects that are less likely to be able to trade are more likely to choose to keep their item, as predicted when reference points are expectation-based, but not when reference points are determined by the status quo or when preferences are reference-independent. In the second experiment, we randomly assign subjects a high or low probability of obtaining an item for free and elicit their willingness-to-accept for it. Being in the high probability treatment increases valuation of the item by 20-30%.
Author: Lorenz Goette
Publisher:
ISBN:
Category :
Languages : en
Pages : 47
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Book Description
An important advance in the study of reference-dependent preferences is the discipline provided by coherent accounts of reference point formation. Kőszegi and Rabin (2006) provide such discipline by positing a reference point grounded in rational expectations. We examine the predictions of Kőszegi and Rabin (2006) in the context of market experiments with probabilistic forced exchange. The experiment tightly tests the predictions of Kőszegi and Rabin (2006), as when the probability of forced exchange increases, individuals should grow more willing to exchange. This mechanism has the theoretical potential to eliminate and even reverse the 'endowment effect' (Knetsch and Sinden, 1984; Knetsch, 1989; Kahneman et al., 1990). Our results uniformly reject these theoretical predictions. In a series of experiments with a total of 930 subjects, sellers' valuations exceed buyers' valuations under all probabilities of forced exchange. In robustness tests where attention is drawn specifically to the forced exchange mechanism, the results are directionally more promising for buyers, but still reject the main thrust of the theoretical predictions. Our findings suggest a potential path forward incorporating failures to completely forecast sensations of gain and loss into models of expectations-based reference dependence.
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Publisher: Elsevier
ISBN: 0444633898
Category : Business & Economics
Languages : en
Pages : 749
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Book Description
Handbook of Behavioral Economics: Foundations and Applications presents the concepts and tools of behavioral economics. Its authors are all economists who share a belief that the objective of behavioral economics is to enrich, rather than to destroy or replace, standard economics. They provide authoritative perspectives on the value to economic inquiry of insights gained from psychology. Specific chapters in this first volume cover reference-dependent preferences, asset markets, household finance, corporate finance, public economics, industrial organization, and structural behavioural economics. This Handbook provides authoritative summaries by experts in respective subfields regarding where behavioral economics has been; what it has so far accomplished; and its promise for the future. This taking-stock is just what Behavioral Economics needs at this stage of its so-far successful career. Helps academic and non-academic economists understand recent, rapid changes in theoretical and empirical advances within behavioral economics Designed for economists already convinced of the benefits of behavioral economics and mainstream economists who feel threatened by new developments in behavioral economics Written for those who wish to become quickly acquainted with behavioral economics
