Expectations as Endowments: Evidence on Reference-Dependent Preferences from Exchange and Valuation Experiments
Keith M. Marzilli Ericson
Markets, Public Policy and Law
Authors: Keith M. Marzilli Ericson and Andreas Fuster
Evidence from a variety of settings indicates that people are loss averse: they dislike losses much more than they enjoy equal-sized gains. Yet little is known about the determination of the reference points relative to which gains and losses are defined. Kahneman and Tversky’s highly influential prospect theory, where loss aversion was first introduced, left the reference point imprecise. It has often been taken to be the status quo. However, we conduct two experiments that show that reference points are determined, at least in part, by expectations about future outcomes. In an exchange experiment, we endow subjects with an item and randomize the probability they will be allowed to trade. Subjects that are less likely to be able to trade are more likely to choose to keep their item. In a valuation experiment, we randomly assign subjects a high or low probability of obtaining an item and elicit their willingness-to-accept for it. The high probability treatment increases valuation of the item by 20–30%. These results imply that firms and policy makers can benefit from “expectations management,” as they may face less resistance against a price or policy change if it was expected than if it comes as a surprise.