Reference Point Formation - Does the Market Whisper in the Background?

33 Pages Posted: 31 Aug 2017

See all articles by Tianyang Wang

Tianyang Wang

Colorado State University - Department of Finance & Real Estate

Sriram V. Villupuram

University of Texas at Arlington - Department of Finance and Real Estate

Robert G. Schwebach

Colorado State University, Fort Collins - College of Business

Date Written: August 29, 2017

Abstract

Experimental studies in behavioral finance historically have confirmed that subjects are highly influenced by reference points when making economic decisions. A recent study by Baucells, Weber and Welfens (2011) analyzed the dynamics of reference price formation using experimental methods with subjects forming reference prices for stocks based on observed price sequences. Their study helps to clarify behavioral effects of past prices on reference price formation but it does not consider contextual information. We extend the BWW study by adding market price information as background to the experiment, and we investigate how this additional information affects reference point formation and updating. Our overarching hypothesis is that if the market background information has no impact then it should not alter the results of BWW; otherwise, the additional market information should be an explanatory variable for the reference point. Our results confirm the hypothesis that market information matters. We also investigate the impact of pessimism and optimism on reference prices by the combining the BWW framework with a model of disappointment aversion and anticipatory feelings developed by Gollier and Muerman (2010). Our study fills a void in the literature by providing new evidence on the impact of contextual market information on reference point formation in an investment setting.

Keywords: behavioral finance; reference-point formation; reference-dependent preferences

JEL Classification: G02

Suggested Citation

Wang, Tianyang and Villupuram, Sriram V. and Schwebach, Robert G., Reference Point Formation - Does the Market Whisper in the Background? (August 29, 2017). Available at SSRN: https://ssrn.com/abstract=3029017 or http://dx.doi.org/10.2139/ssrn.3029017

Tianyang Wang (Contact Author)

Colorado State University - Department of Finance & Real Estate ( email )

Finance and Real Estate Department
1272 Campus Delivery
Fort Collins, CO 80523
United States

Sriram V. Villupuram

University of Texas at Arlington - Department of Finance and Real Estate ( email )

Box 19449 UTA
Arlington, TX 76019
United States

Robert G. Schwebach

Colorado State University, Fort Collins - College of Business ( email )

Dept. of Finance & Real Estate
Fort Collins, CO 80523
United States
970-491-5547 (Phone)
970-491-7665 (Fax)

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