A Reference Dependent Regret Theory
39 Pages Posted: 8 Jul 2021
Date Written: May 25, 2021
We propose an extension of the classical regret theory model (Loomes & Sugden, 1982; henceforth LS) incorporating the notion of a reference point. As in LS, the model can account for a number of documented deviations from expected utility theory. Additionally, we show that our model is consistent with a class of behaviors known as omission bias, for example a reluctance to exchange lottery tickets, and generates predictions which are consistent with recent empirical evidence on the common-ratio effect with correlated outcomes. The model also provides a novel interpretation for risk aversion in small-stakes, equiprobable gambles. The predictive power of the theory, as well as its relative shortcomings and advantages, are examined and compared to that of other extensions of regret theory and three alternative reference-dependent models.
Keywords: Regret Theory, Reference Point, Risky Choice, Omission Bias, Lottery Exchange
JEL Classification: D03, D81
Suggested Citation: Suggested Citation