CeDEx workshop - Sudeep Bhatia (University of Warwick)

The Construction of Reference-Dependent Preferences

Abstract: I present a theory of riskless reference dependence, which assumes that reference points act as primes, increasing attention towards the attributes that they are associated with. Changing reference points alters the attentional weights on these attributes, subsequently biasing choice. I first develop the psychological foundations of this theory using a sequential sampling model. This model accounts for empirical results on attention,  recall, and decision time, observed in reference-dependent choice, and also generates loss-aversion without making any explicit assumptions about asymmetries in gains and losses. I then use this model to derive a tractable utility representation, which I show provides a parsimonious account of a wide range of reference-dependent choice behaviors, without large deviations from standard economic theory. Finally, I outline a number of novel predictions of the proposed model that differentiate it from prospect theory based accounts of reference dependence. I use these predictions to experimentally compare the two theories and find that attentional reference dependence provides a better quantitative fit to choice data relative to existing prospect theory models.