Reference Point Formation Over Time: A Weighting Function Approach

Abstract

Although the concept of reference point dependent preferences has been adapted to almost all fields of behavioral economics (especially marketing and behavioral finance), we still know very little about how decision makers form their reference points given a sequence of prices. Our paper provides both a theoretical framework on reference point formation over time, based on cumulative prospect theory's inverse s-shaped weighting function, and a new experimental method for eliciting subjects' individual reference points in a finance context. Consistent with our model, we document our student subjects' reference points to be best described by the first and the last price of the time series, with intermediate prices receiving smaller weights