An experiment by: K. Ericson and A. Fuster Evidence on Reference-Dependent Preferences from Exchange Valuation Experiments An experiment by: K. Ericson and A. Fuster By Harry Marshall

Quick Summary: Evidence from a variety of settings indicates that people are loss adverse. This simply means that they dislike losses much more than they enjoy equal-sized gains. Despite our knowledge of this trait in humans little is known about the determination of the reference points relative to which gains and losses are defined. One of the most common assumptions is that this reference point is given by a person’s current endowment. Ericson and Fuster attempt to provide evidence that a person’s expectations about outcomes determine their reference points.

Experiment One: Expectations and Exchange Behaviour When subjects arrive at the lab they are endowed with an item (university travel mug) Subjects allocated randomly assigned probability of exchanging their item for another (university metal pen) Subjects asked to complete personality questionnaire to both distract them and provide them with time to think Subjects are asked to make their decision re; keep item or trade Result: The results were that subjects who had a 10% chance of being able to exchange items were significantly less likely to be willing to exchange than subjects that had a 90% chance.

Experiment Two: Expectations and Valuation Subjects are seated at a desk with a mug on it and assigned probabilities of either 10% or 80% randomly and transparently Subjects are told that if a ten-sided die that is rolled individually for each subject at the end of the study comes up lower than their index card they will receive the mug in front of them for free and leave with it at the end of the experiment. They are also told that if the die comes up 9 they will have the option to keep the mug or exchange it for a randomly determined amount of money between $0-$10

Experiment Two Cont. Thus, subject’s who coin came up 1 have a 10% chance of receiving the mug without making a choice while subjects who’s coin came up 8 have an 80% chance of receiving the mug without making a choice. Subjects in both treatments have a 10% chance of having a choice between the money and the mug The next phase of the experiment is then identical to experiment one; filling out a personally questionnaire. They are also asked to make choices between different monetary amounts or keeping the mug (and not getting the money). From here, if the die comes up with 9, they will receive their choice from one randomly selected row.

Experiment Two Cont. The subjects are then told that in the case the die comes up with 8 (where they previously expected to get neither mug nor money) they will get their choice between a pen and a randomly determined dollar amount. They are then given the pen to inspect and are again asked to make choices between keeping the pen and different dollar amounts. Result: subjects that had a high chance of leaving with the mug value it significantly higher than subjects that have a lower chance of leaving with the mug.

Conclusion: Increasing a subject’s expectation of leaving with an item has an effect on both: Exchange behaviour (they are more likely to keep the item) and Valuation (they demand more compensation to give it up) Reference points are determined, at least in part, by expectations. However while this is the case other factors such as social norms, aspirations, salience, and history may also influence reference points and will require further experimentation in the future