Understanding the Reference Effect

This paper explores how a change in reference point affects individual preferences. While reference dependence is extensively studied, very little is known regarding the impact of reference points on individual choice behavior when the reference points them-selves are not chosen (Reference Effect). We study when the reference effect exists and how it operates. We find that the reference effect exists for asymmetrically dominated reference points but we do not see any evidence of reference effect for symmetrically dominated reference points. Our experiment can also distinguish among the models of reference-dependence with exogenously determined reference points, even though these models were initially constructed in order to explain the same choice anomalies. We illustrate that the model of Masatlioglu and Ok [2010] is consistent with our data for asymmetrically dominated reference points and also predicts no reference effect for sym-metrically dominated reference points. We are indebted to Efe A. Ok who has guided the development of this paper. We also thank Yan Chen, Ro