Reference Dependence Choice Heuristics : Decision Making Under Risk

Faculty Development Competitive Research Grant Program 2018-2020

The primary emphasis of this research project is to develop, test and apply a theory and explore the implications of reference-dependent heuristics for various reference-dependent preference structures widely used in economics, finance and decision sciences. The proposed research is, in essence, seeking to create a generalized notion of personal equilibrium based on rank-dependent utility and reference-dependent heuristics, rather than reference-dependent optimization under disappointment aversion, as is prevalent in the literature. We start with the observations that (1) it is too difficult for a bounded-rational decision maker to solve the relevant problem of optimizing reference-dependent utility function and (2) the relevant solution would obey a number of undesirable properties such as the disappearance of loss aversion under regret aversion or rank-dependent utility. Hence this study intends to put the rank-dependent preferences and cognitive burden at the forefront of the theory, and explores the implications of our rank-dependent preference and search heuristics. The primary emphasis represents a major new direction of research that should develop into a fruitful and exciting area of economic theory, building on De Giorgi and Post (2011). The second emphasis of the project will be to study and provide empirical support to our idea of reference-dependent heuristics, mainly through the experimental approach. The project intends to create and conduct a series of economic experiments that would build on our previous work (Post et al, 2008, Baltussen, Post, Vliet 2006, Baltussen et al 2012) on the subject. Our project contributes to the area of micro-foundation of preferences, with far reaching applications in the area and proper understanding of insurance choices, anchoring effects around subsidies, asset allocation and economic applications of prospect theory in general.