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A theory of reference point formation

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Abstract

We introduce a model of reference-dependent choice where the reference point is endogenously determined through maximization of a conspicuity ranking. This subjective ranking captures how prominent or eye-catching the alternatives are relative to one another. The most conspicuous alternative in a choice set serves as the reference point and in turn determines the reference-dependent utility function the decision maker maximizes to make a choice. We show that this conspicuity based endogenous reference model (CER) is characterized by an intuitive and simple behavioral postulate, called the Single Reversal, and we discuss how choice data can be used to reveal information about CER’s parameters. We additionally analyze special cases where a reference-free utility function, combined with psychological constraints, is used to make reference-dependent choices.

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Acknowledgements

Financial support from the National Science Foundation through grant SES-1628883 is gratefully acknowledged. We thank the editor, the associate editor, and three anonymous reviewers for helpful comments and suggestions.

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Authors and Affiliations

  1. Faculty of Arts and Social Sciences, Sabancı University, Istanbul, 34956, Turkey

    Özgür Kıbrıs

  2. Department of Economics, University of Maryland, College Park, MD, 20742, USA

    Yusufcan Masatlioglu

  3. Department of Economics, Purdue University, West Lafayette, IN, 47907, USA

    Elchin Suleymanov

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  1. Özgür Kıbrıs
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  2. Yusufcan Masatlioglu
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Correspondence to Elchin Suleymanov.

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Kıbrıs, Ö., Masatlioglu, Y. & Suleymanov, E. A theory of reference point formation. Econ Theory 75, 137–166 (2023). https://doi.org/10.1007/s00199-021-01392-3

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