A Reference Dependent Regret Theory

39 Pages Posted: 8 Jul 2021

See all articles by Felipe A. Araujo

Felipe A. Araujo

Lehigh University - Department of Economics

Yuval Erez

Lehigh University - Department of Economics

Pengfei Zhang

Cornell University, Ithaca, New York

Date Written: May 25, 2021

Abstract

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

Augusto de Araujo, Felipe and Erez, Yuval and Zhang, Pengfei, A Reference Dependent Regret Theory (May 25, 2021). Available at SSRN: https://ssrn.com/abstract=3878558

Felipe Augusto de Araujo (Contact Author)

Lehigh University - Department of Economics ( email )

620 Taylor Street
Bethlehem, PA 18015
United States

HOME PAGE: http://https://www.araujofa.com

Yuval Erez

Lehigh University - Department of Economics ( email )

620 Taylor Street
Bethlehem, PA 18015
United States

Pengfei Zhang

Cornell University, Ithaca, New York ( email )

New York
United States

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