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Choosing with the Worst in Mind: A Reference-Dependent Model

Tserenjigmid, Gerelt (2014) Choosing with the Worst in Mind: A Reference-Dependent Model. Social Science Working Paper, 1391. California Institute of Technology , Pasadena, CA. (Unpublished) http://resolver.caltech.edu/CaltechAUTHORS:20170726-141339637

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Abstract

We develop an axiomatic model of reference-dependent preferences in which reference points are menu-dependent. In particular, we focus on choices from menus of two-attribute alternatives, and the reference point for the given menu is a vector that consists of the minimums of each dimension of the menu. We characterize this model by two weakenings of the Weak Axiom of Revealed Preference (WARP) in addition to standard axioms. Our model is consistent with the attraction effect and the compromise effect, well-known deviations from rational choice theory, and it provides a connection between the two effects and diminishing sensitivity, a widely used behavioral property in economics. We apply the model to two different contexts, intertemporal choice and risky choice, and diminishing sensitivity has interesting implications. In intertemporal choice, the main implication of the model is that borrowing constraints produce a psychological pressure to move away from the constraints even if they are not binding. This implication provides a rationale for two empirical puzzles of life-cycle consumption profiles. In risky choice, the model allows different degrees of risk-aversion.


Item Type:Report or Paper (Working Paper)
Additional Information:Revised November 2014. I am indebted to Federico Echenique and Pietro Ortoleva for their advice, guidance, and encouragement. I also thank Colin Camerer and Kota Saito for valuable discussions.
Group:Social Science Working Papers
Subject Keywords:Reference-Dependence; Menu-Dependent Reference; WARP; Attraction Effect; Compromise Effect; Diminishing Sensitivity; Intertemporal Choice; Risky Choice
Classification Code:JEL: D01, D81, D91
Record Number:CaltechAUTHORS:20170726-141339637
Persistent URL:http://resolver.caltech.edu/CaltechAUTHORS:20170726-141339637
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:79432
Collection:CaltechAUTHORS
Deposited By: Hanna Storlie
Deposited On:07 Aug 2017 21:50
Last Modified:07 Aug 2017 21:50

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