Reference Point Adaptation: Tests in the Domain of Security Trading
Organizational Behavior and Human Decision Processes, Vol. 105, No. 1, pp. 67-81, January 2008
32 Pages Posted: 28 Jun 2006 Last revised: 19 Oct 2008
Date Written: January 1, 2008
According to prospect theory (Kahneman & Tversky, 1979), gains and losses are measured from a reference point. We attempted to ascertain to what extent the reference point shifts following gains or losses. In questionnaire studies we asked subjects what stock price today will generate the same utility as a previous change in a stock price. From participants' responses we calculated the magnitude of reference point adaptation, which was significantly greater following a gain than following a loss of equivalent size. We also found the asymmetric adaptation of gains and losses persisted when a stock was included within a portfolio rather than being considered individually. In studies using financial incentives within the Becker, DeGroot, and Marschak (1964) procedure, we again noted faster adaptation of the reference point to gains than losses. We related our findings to several aspects of asset pricing and investor behavior.
Keywords: Prospect theory, Reference point, Asset pricing, Security trading
JEL Classification: C91, D81
Suggested Citation: Suggested Citation