Reference Point Formation in Social Networks, Wealth Growth, and Inequality

39 Pages Posted: 4 Aug 2017 Last revised: 25 Jun 2019

See all articles by Youcheng Lou

Youcheng Lou

Chinese Academy of Sciences (CAS) - Academy of Mathematics and Systems Science

Moris Simon Strub

Southern University of Science and Technology - Division of Information Systems and Management Engineering

Duan Li

Chinese University of Hong Kong; City University of Hong Kong

Shouyang Wang

Chinese Academy of Sciences (CAS) - Center for Forecasting Science; Academy of Mathematics and Systems Sciences

Date Written: August 3, 2017

Abstract

We investigate reference point formation in a social network of multiple investors and study its impact on wealth growth and inequality under a framework of Prospect Theory. The reference point of each individual investor contains both personal and social components. Whereas the personal component depends on the investor’s own history of wealth, the social component is determined by the wealth level of other investors in her network. In the benchmark case without social interactions and under the assumption of homogeneous preferences, each investor’s expected wealth grows at a common rate, the wealth gaps widens and the Gini coefficient remains constant. On the other hand, if the reference point is determined solely by social interactions, then, while the specific behavior depends on the model parameters, it is possible that the network simultaneously experiences high wealth growth and a reduction in inequality. Finally, for the general case where the reference point incorporates both personal and social components, we numerically show that increasing the degree of social interaction is beneficial for both increasing wealth growth and
reducing inequality.

Keywords: Cumulative Prospect Theory (CPT), Reference Point, Coefficient of Aspiration, Wealth Growth, Wealth Inequality, Gini Coefficient

JEL Classification: G11, G41

Suggested Citation

Lou, Youcheng and Strub, Moris Simon and Li, Duan and Wang, Shouyang, Reference Point Formation in Social Networks, Wealth Growth, and Inequality (August 3, 2017). Available at SSRN: https://ssrn.com/abstract=3013124 or http://dx.doi.org/10.2139/ssrn.3013124

Youcheng Lou

Chinese Academy of Sciences (CAS) - Academy of Mathematics and Systems Science ( email )

Beijing
China

Moris Simon Strub

Southern University of Science and Technology - Division of Information Systems and Management Engineering ( email )

1088 Xueyuan Ave
Shenzhen, Guangdong
China

HOME PAGE: http://sites.google.com/view/morisstrub/home

Duan Li (Contact Author)

Chinese University of Hong Kong ( email )

Shatin, New Territories
Hong Kong

City University of Hong Kong

Tat Chee Avenue
Kowloon Tong
Kowloon
Hong Kong
852 3442 8591 (Phone)

Shouyang Wang

Chinese Academy of Sciences (CAS) - Center for Forecasting Science; Academy of Mathematics and Systems Sciences ( email )

China

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