A tri-reference point theory of decision making under risk.

Abstract

The tri-reference point (TRP) theory takes into account minimum requirements (MR), the status quo (SQ), and goals (G) in decision making under risk. The 3 reference points demarcate risky outcomes and risk perception into 4 functional regions: success (expected value of x ≥ G), gain (SQ < × < G), loss (MR ≤ x < SQ), and failure (x < MR). The psychological impact of achieving or failing to achieve these reference points is rank ordered as MR > G > SQ. We present TRP assumptions and value functions and a mathematical formalization of the theory. We conducted empirical tests of crucial TRP predictions using both explicit and implicit reference points. We show that decision makers consider both G and MR and give greater weight to MR than G, indicating failure aversion (i.e., the disutility of a failure is greater than the utility of a success in the same task) in addition to loss aversion (i.e., the disutility of a loss is greater than the utility of the same amount of gain). Captured by a double-S shaped value function with 3 inflection points, risk preferences switched between risk seeking and risk aversion when the distribution of a gamble straddled a different reference point. The existence of MR (not G) significantly shifted choice preference toward risk aversion even when the outcome distribution of a gamble was well above the MR. Single reference point based models such as prospect theory cannot consistently account for these findings. The TRP theory provides simple guidelines for evaluating risky choices for individuals and organizational management.

Rawlsian maximin rule operates as a common cognitive anchor in distributive justice and risky decisions

“…Research using behavioral games has shown that, when making distributive choices for others, people generally prefer to improve everyone's payoffs but are more concerned about raising the payoffs of the worse-off individuals than the better-off individuals (4)(5)(6)(7). Similarly, in the riskydecision-making literature, parallel evidence is emerging that people often pay particular attention to their worst possible payoff as well as the expected mean when choosing among gambles (8,9). Maximin strategies (those that maximize the minimum outcome) in risky choices are also used by some nonhuman animals during foraging (10), which likely reflects that real-world concerns about risk are often dominated by the rarest but most disastrous outcome (11).…”

“…Of course, ideologies and choice preferences vary across individuals, ranging from "Rawlsian" [maximizing the minimum (3)] to "utilitarian" [overall maximizing (19,27)] in distributions for others (4)(5)(6)(7)14), and from risk avoiding to risk seeking in economic decisions for self (8)(9)(10)(11). However, we predict that, across tasks and individual differences, the minimum, worst-case scenario will tend to be a primary locus of perspective taking and function as a spontaneous cognitive anchor.…”

The Newsvendor Problem Based on Multiple Reference Points

“…Kacelnik [12] reveals the importance of minimum requirement reference point. Wang and Johnson (2012) [11] further propose that the most important psychological preference is MR reference. As far as we know, Wang and Webster [6] use a conception of loss-aversion to illustrate decision bias.…”

“…However, the research of multiple reference point gives a larger concept which can be applied to analyze decision bias. Wang and Johnson (2012) [11] show a tri-reference point theory which summarize three reference point, MR, SQ and G (MR refers to minimum requirement; SQ refers to status quo; G refers to goal). Kacelnik [12] reveals the importance of minimum requirement reference point.…”

Social Comparison and Risk Taking Behavior

“…10 A recent strand of literature on behavioral decision making considers that decision makers' attitudes may be influenced by the presence of multiple individual reference points (see, for example, Wang andJohnson, 2012, andMarch andShapira, 1992). For experimental evidence see Sullivan and Kida, 1995, Ordóñez et al, 2000, Koop and Johnson, 2010 We thus assume v(x; r, s) = u(x − r) + g(x − s), where both u(·) and g(·) are increasing in x and g(·) is concave in social gain (x > s) and convex in social loss (x < s).…”