Expectation-Based Loss Aversion and Strategic Interaction

45 Pages Posted: 15 Mar 2017  

Simon Dato

University of Bonn

Andreas Grunewald

University of Bonn - Economic Science Area

Daniel Mueller

Saarland University

Philipp Strack

University of California, Berkeley - Department of Economics

Date Written: March 10, 2017

Abstract

Extending the equilibrium concepts of Kőszegi and Rabin (2006, 2007), this paper analyzes the strategic interaction of expectation-based loss-averse players. For loss-averse players with choice-acclimating expectations the utility from playing a mixed strategy is not linear but convex in the probabilities they assign to their pure strategies. As a consequence, they are generally unwilling to randomize and an equilibrium may fail to exist. For players with choice-unacclimating expectations, in contrast, randomizing over their pure strategies may indeed constitute a credible best response and an equilibrium always exist. Building upon these insights, we delineate how expectation-based loss-averse players differ in their strategic behavior from their counterparts with standard expected-utility preferences, derive novel strategic effects, discuss equilibrium selection, and derive equilibrium play for some simple games.

Keywords: Non-Cooperative Games, Expectation-Based Loss Aversion, Reference-Dependent Preferences, Mixed Strategies

JEL Classification: C72, D01, D03, D81

Suggested Citation

Dato, Simon and Grunewald, Andreas and Mueller, Daniel and Strack, Philipp, Expectation-Based Loss Aversion and Strategic Interaction (March 10, 2017). Available at SSRN: https://ssrn.com/abstract=2932326

Simon Dato

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

Andreas Grunewald

University of Bonn - Economic Science Area ( email )

Adenauerallee 24-42
D-53113 Bonn
Germany

Daniel Mueller (Contact Author)

Saarland University ( email )

Stadtwald
Saarbrucken, Saarland D-66123
Germany

Philipp Strack

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States

HOME PAGE: http://philippstrack.com

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