Skip to main content
SpringerLink
Log in

How expectations affect reference point formation: an experimental investigation

  • Original Paper
  • Published:
Review of Managerial Science Aims and scope Submit manuscript

Abstract

This paper addresses two major topics concerning the role of expectations in the formation of reference points. First, we show that when expectations are present, they have a significant impact on reference point formation. Second, we find that decision-makers employ expected values when forming reference points (integrated mechanism) as opposed to single possible outcomes (segregated mechanism). Despite the importance of reference points in prospect theory, to date, there is no standard method of examining these. We develop a new experimental design that employs an indirect approach and extends an existing direct approach. Our findings are consistent across the two approaches.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. We follow Köszegi and Rabin (2006, 2007) and consider those expectations held in the “recent” past (t = 1) about current outcomes (t = 2). As they point out, this should not mean that beliefs are slow to adjust to new information but that preferences do not instantaneously change when beliefs do. They give the following example for this setting: “When somebody finds out 5 min ahead of time that she will for sure not receive a long-expected $100, she would presumably immediately adjust her expectations to the new situation, but she will still 5 min later assess not getting the money as a loss” (Köszegi and Rabin 2006, footnote 9).

  2. Note that in contrast to Fig. 1, there is no actual outcome P1 in t = 1 when the lotteries are announced. This intermediate outcome P1 will become meaningful in Experiment 2.

  3. The higher willingness of those participants in the experimental treatments to take risks, even if not significant, could first be due to the “hot hand effect” (Rabin and Vayanos 2010; Croson and Sundali 2005). Participants in the experimental treatments won the higher amount of money during the first lottery and thus might believe in a run of good luck. Second, the higher willingness could be due to the more pronounced “house-money effect” (Thaler and Johnson 1990) as participants in the experimental treatments received a higher amount of money (8 CHF or 12 CHF) compared with those in the control treatment (4 CHF).

  4. For the effects of learning in sequential-choice settings see March (1996) or Erev and Barron (2005).

  5. As we asked participants to reveal their expectations about the current stock price, we are able to statistically compare this information for both treatments. The mean reported expectations in the control treatment with 39.16€ are approximately the same size as those in the base treatment A (B) with 38.54€ (39.55€). Statistical comparisons show no significant differences (A: Mann–Whitney-U = 4,161.50; p = 0.663; B: Mann–Whitney-U = 1,992.5; p = 0.324).

  6. Reference point adaptation high treatment A (7.88€) minus reference point adaptation base treatment A (5.69€).

  7. Reference point adaptation base treatment A (5.69€) minus reference point adaptation low treatment A (4.09€).

  8. A statistical comparison of the squared differences in reference point adaptation compared with the base treatment for treatments low and high A confirms the differences on a significant level (U = 1,866.00; p = 0.046). This is not true for the comparison between treatments low and high B (U = 2,269.00; p = 0.943).

  9. For a possible range effect, see, for example, Curley and Yates (1985).

References

  • Abdellaoui M (2000) Parameter-free elicitation of utility and probability weighting. Manag Sci 46(11):1497–1512

    Article  Google Scholar 

  • Abdellaoui M, Bleichrodt H, Paraschiv C (2007) Loss aversion under prospect theory: a parameter-free measurement. Manag Sci 53:1659–1674

    Article  Google Scholar 

  • Abeler J, Falk A, Götte L, Huffman D (2011) Reference points and effort provision. Am Econ Rev 101:470–492

    Article  Google Scholar 

  • Arkes HR, Hirshleifer D, Jiang D, Lim S (2008) Reference point adaptation: tests in the domain of security trading. Organ Behav Hum Decis Process 105:67–81

    Article  Google Scholar 

  • Bartol KM, Martin DC (1998) Applicant referent information at hiring interview and subsequent turnover among part-time workers. J Vocat Behav 53:334–352

    Article  Google Scholar 

  • Baucells M, Weber M, Welfens F (2011) Reference-point formation and updating. Manag Sci 57(3):506–519

    Article  Google Scholar 

  • Bell DR, Lattin JM (2000) Looking for loss aversion in scanner panel data. The confounding effect of price response heterogeneity. Mark Sci 19(2):185–200

    Article  Google Scholar 

  • Breiter HC, Aharon I, Kahneman D, Dale A, Shizgal P (2001) Functional imaging of neural responses to expectancy and experience of monetary gains and losses. Neuron 30:619–639

    Article  Google Scholar 

  • Chen HA, Rao AR (2002) Close encounters of two kinds: false alarm and dashed hopes. Mark Sci 21(2):178–196

    Article  Google Scholar 

  • Croson R, Sundali J (2005) The gambler’s fallacy and the hot hand: empirical data from casinos. J Risk Uncertain 30(3):195–209

    Article  Google Scholar 

  • Curley SP, Yates JF (1985) The center and range of the probability interval as factors affecting ambiguity preferences. Organ Behav Hum Decis Process 36(2):273–287

    Article  Google Scholar 

  • De Meza D, Webb DC (2007) Incentive design under loss aversion. J Eur Econ Assoc 5(1):66–92

    Article  Google Scholar 

  • Diener E, Sandvik E, Pavot W (1990) Happiness is the frequency, not intensity, of positive versus negative affect. In: Strack F, Argyle M, Schwarz N (eds) The social psychology of subjective well-being. Pergamon, New York

    Google Scholar 

  • Erev I, Barron G (2005) On adaptation, maximization, and reinforcement learning among cognitive strategies. Psychol Rev 112(4):912–931

    Article  Google Scholar 

  • Fehr-Duda H, De Gennaro M, Schubert R (2006) Gender, financial risk, and probability weights. Theor Decis 60(2–3):283–313

    Article  Google Scholar 

  • Gilovich T, Vallone R, Tversky A (1985) The hot hand in basketball: on the misperception of random sequences. Cogn Psychol 17(3):295–314

    Article  Google Scholar 

  • Gneezy U (2005) Updating the reference level: experimental evidence. In: Zwick R, Rapoport A (eds) Experimental business research. Springer, Dordrecht, pp 263–284

    Chapter  Google Scholar 

  • Heath C, Larrick RP, Wu G (1999) Goals as reference points. Cogn Psychol 38(1):79–109

    Article  Google Scholar 

  • Helson H (1964) Adaptation-level theory: an experimental and systematic approach to behavior. Harper and Row, New York

  • Heyman J, Mellers B, Tishcenko S, Schwartz A (2004) I was pleased a moment ago: how pleasure varies with background and foreground reference points. Motiv Emot 28(1):65–83

    Article  Google Scholar 

  • Highhouse S, Brooks-Laber ME, Lin L, Spitzmueller C (2003) What makes a salary seem reasonable? Frequency context effects on starting-salary expectations. J Occup Organ Psychol 76(1):69–81

    Article  Google Scholar 

  • Hoeffler S, Ariely D, West P (2006) Path dependent preferences: the role of early experience and biased search in preference development. Organ Behav Hum Decis Process 101:215–229

    Article  Google Scholar 

  • Holt CA, Laury SK (2002) Risk aversion and incentive effects. Am Econ Rev 92(5):1644–1655

    Article  Google Scholar 

  • Kahneman D (1992) Reference points, anchors, norms, and mixed feelings. Organ Behav Hum Decis Process 51:296–312

    Article  Google Scholar 

  • Kahneman D, Tversky A (1979) Prospect theory: an analysis of decision under risk. Econometrica 47(2):263–291

    Article  Google Scholar 

  • Kahneman D, Knetsch JL, Thaler R (1986) Fairness as a constraint on profit seeking: entitlements in the market. Am Econ Rev 76:728–741

    Google Scholar 

  • Kameda T, Davis JA (1990) The function of the reference point in individual and group risk decision making. Organ Behav Hum Decis Process 46(1):55–76

    Article  Google Scholar 

  • Klein HJ (1991) Further evidence on the relationship between goal setting and expectancy theories. Organ Behav Hum Decis Process 49:230–257

    Article  Google Scholar 

  • Koop GJ and Johnson JG (2010) The use of multiple reference points in risky decision making. J Behav Decis Mak 25(1):49–62

    Google Scholar 

  • Köszegi B, Rabin M (2006) A model of reference-dependent preferences. Q J Econ 121(4):1133–1165

    Google Scholar 

  • Köszegi B, Rabin M (2007) Reference-dependent risk attitudes. Am Econ Rev 97(4):1047–1073

    Article  Google Scholar 

  • Lin C-H, Huang W-H, Zeelenberg M (2006) Multiple reference points in investor regret. J Econ Psychol 27(6):781–792

    Article  Google Scholar 

  • March JG (1996) Learning to be risk averse. Psychol Rev 103(2):309–319

    Article  Google Scholar 

  • Mazumdar T, Raj SP, Sinha I (2005) Reference price research: review and propositions. J Market 69:84–102

    Article  Google Scholar 

  • Medvec VH, Madey SF, Gilovich T (1995) When less is more: counterfactual thinking and satisfaction among Olympic medalists. J Pers Soc Psychol 69(4):603–610

    Article  Google Scholar 

  • Mellers B, Schwartz A, Ho K, Ritov I (1997) Elation and disappointment: emotional responses to risky options. Psychol Sci 8(6):423–429

    Article  Google Scholar 

  • Mellers B, Schwartz A, Ritov I (1999) Emotion-based choice. J Exp Psychol Gen 128(3):332–345

    Article  Google Scholar 

  • Ordonez LT, Connolly R, Coughlan R (2000) Multiple reference points in satisfaction and fairness assessment. J Behav Decis Mak 13:329–344

    Article  Google Scholar 

  • Post T, Van den Assem MJ, Baltussen G, Thaler RH (2008) Deal or no deal? Decision making under risk in a large-payoff game show. Am Econ Rev 98(1):38–71

    Article  Google Scholar 

  • Rabin M, Vayanos D (2010) The gambler’s and hot-hand fallacies: theory and applications. Rev Econ Stud 77(2):730–778

    Article  Google Scholar 

  • Schmidt U, Zank H (2012) A genuine foundation for prospect theory. J Risk Uncertain 45:97–113

    Article  Google Scholar 

  • Short JC, Palmer TB (2003) Organizational performance referents: an empirical examination of their content and influences. Organ Behav Hum Decis Process 90(2):209–224

    Article  Google Scholar 

  • Sulivan K, Kida T (1995) The effect of multiple reference points and prior gains and losses on managers’ risky decision making. Organ Behav Hum Decis Process 64(1):76–83

    Article  Google Scholar 

  • Thaler RH, Johnson EJ (1990) Gambling with the house-money and trying to break even: the effect of prior outcomes on risky choice. Manag Sci 36(6):643–660

    Article  Google Scholar 

  • Tversky A, Kahneman D (1992) Advances in prospect theory: cumulative representation of uncertainty. J Risk Uncertain 5(4):297–323

    Article  Google Scholar 

  • Winer RS (1986) A reference price model of brand choice for frequently purchased products. J Consum Res 13(2):250–256

    Article  Google Scholar 

Download references

Acknowledgments

This research was supported by the Deutsche Forschungsgemeinschaft (DFG) awarded to Frauke von Bieberstein. We gratefully acknowledge support from the Volkswagen Foundation, Grant no. 85 487.

Author information

Authors and Affiliations

  1. Institute for Organization and Human Resource Management, University of Bern, Engehaldenstrasse 4, 3012, Bern, Switzerland

    Andreas Hack & Frauke von Bieberstein

Authors
  1. Andreas Hack
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Frauke von Bieberstein
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Andreas Hack.

Appendices

Appendix 1: Instructions for the experiment (treatment 1)

Welcome to this experiment! Please read these instructions carefully. All decisions you make in this experiment are anonymous. At the end of the experiment you will also be paid out anonymously. During the experiment no communication is allowed.

  1. 1.

    Personal information

How old are you?; What is your field of study?; Please indicate your gender.

  1. 2.

    General information

We will be playing two lotteries with you where you can win real money.

To do so we have divided all participants into two groups: Group A and Group B.

You are part of: Group A.

  1. 3.

    Lottery One

The first lottery has the following payoffs:

Win 4 CHF with 50 % probability/Win 8 CHF with 50 % probability

We will now toss a coin. Your payoff will be calculated in the following way:

“Heads”: Group A wins 4 CHF, Group B wins 8 CHF/

“Tails”: Group A wins 8 CHF, Group B wins 4 CHF.

  1. 4.

    Lottery Two

The table below shows in each row two alternatives. You can choose in each row between participation in a lottery (Alternative 1) or a safe payment (Alternative 2).

Please fill in the table below as follows: Start with the first row and move down from row to row. In each row, you have to decide between Alternative 1 and 2. Alternative 1 is the same in each row. Only the safe payment in Alternative 2 increases with each row.

After you have made your choices, we will select one of the rows by chance. This row will determine your payment: If you have selected Alternative 1 in this row, we will play the lottery with you. If you have selected Alternative 2 in this row, you will receive the safe payment.

Please mark in each row only one alternative with a cross (all in all 17 crosses):

Row

Alternative 1

Alternative 2

1

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

0 CHF for sure

2

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

0.50 CHF for sure

3

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

1 CHF for sure

4

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

1.50 CHF for sure

5

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

2 CHF for sure

6

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

2.50 CHF for sure

7

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

3 CHF for sure

8

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

3.50 CHF for sure

9

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

4 CHF for sure

10

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

4.50 CHF for sure

11

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

5 CHF for sure

12

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

5.50 CHF for sure

13

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

6 CHF for sure

14

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

6.50 CHF for sure

15

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

7 CHF for sure

16

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

7.50 CHF for sure

17

10 CHF with probability of 50 %,

0 CHF with probability of 50 %

8 CHF for sure

Appendix 2: Instructions for the questionnaire study

Thank you for participating in our short questionnaire study!

Please complete the following questionnaire. Take your time and carefully read the questions. There are no right or wrong answers in the second and third part of the questionnaire. We are only interested in your personal assessment. All answers will be made anonymous.

  1. 1.

    Personal information

How old are you?; What is your field of study?; Please indicate your gender.

  1. 2.

    Personal assessment

Please imagine the following situation:

“Two months ago, you bought a stock for 30€ per share. One month ago, you were delighted to learn the stock was trading higher—at 36€ per share. [Only in experimental treatments: One month ago you also learned that this month’s stock price is expected to range between x and y€, with each price within this interval being equally likely.]

This month, you decide to check the stock’s price again. At what price would the stock need to trade today to make you just as happy with the stock’s price this month as you were when you learned the stock had risen from 30 to 36€ last month?”

Please indicate the stock price that would make you just as happy here:

  1. 3.

    Further information

Please indicate what stock price you had expected when answering the question on the previous page on “the stock price that would make you just as happy”.

Please indicate the stock price that you had expected here:

Rights and permissions

Reprints and permissions

About this article

Cite this article

Hack, A., von Bieberstein, F. How expectations affect reference point formation: an experimental investigation. Rev Manag Sci 9, 33–59 (2015). https://doi.org/10.1007/s11846-014-0121-0

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11846-014-0121-0

Keywords

JEL Classification

Search

Navigation