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School of Economics and Finance Seminar Meaningful Theorems: Nonparametric Analysis of Reference-Dependent Preferences

Speaker: Professor Vincent Crawford, University of Oxford

Abstract: We derive nonparametric sufficient and asymptotically necessary conditions for the existence of reference-dependent preferences, as in Koszegi and Rabin's (2006) structural implementation of Kahneman and Tversky's (1979) prospect theory, that can rationalize some consumer demand choices that violate the conditions for a neoclassical rationalization. Our conditions relax Koszegi and Rabin's and others' assumption of additive separability across goods. Unless prospect theory's notion of sensitivity is constant and reference points are precisely modelable or observable, the hypothesis of reference-dependent preferences has few or no nonparametrically refutable implications. But with constant sensitivity and modelable reference points, the model has useful implications. For almost all of Farber's (2005, 2008) cabdrivers, models that relax additive separability across goods have higher measures of predictive success (Selten and Krischker 1983) than their additively separable counterparts. For roughly half of the drivers, reference-dependent models that relax additive separability have higher Selten measures than their neoclassical counterparts.

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