School Choice and Loss Aversion

Abstract

Extensive evidence suggests that participants in the direct student-proposing deferred-acceptance mechanism (DSPDA) play dominated strategies. In particular, students tend to misrepresent preferences for their top choices. To explain the observed data, we introduce expectation-based loss aversion into a school-choice setting and characterize choice-acclimating personal equilibria in DSPDA. We find that only top-choice monotone rank-ordered lists can be strictly optimal, and truthful equilibria can fail to exist. In equilibirum, DSPDA may implement unstable allocations in both large and small markets. Specifically, it discriminates against students who are more loss averse or less confident than their peers, and amplifies already existing (or perceived) discrimination. To level the playing field, we propose sequential mechanisms as a strategyproof and stable alternative that is robust to these biases.

Keywords: Market design, Matching, School choice, Reference-dependent preferences, Loss aversion, Deferred acceptance

JEL Classification: C78, D47, D78, D81, D82, D91