A Theory of Reference-Dependent Behavior

• Authors: Miguel Ángel Ballester and Jose Apesteguia.
• BSE Working Paper: 323 | September 15
• Keywords: habit formation , Rationalization , individual rationality , reference-dependence , path independence , status-quo bias , addiction
• JEL codes: A12, B41, D11.
• habit formation
• Rationalization
• individual rationality
• reference-dependence
• path independence
• status-quo bias
• addiction

Extensive field and experimental evidence in a variety of environments show that behavior depends on a reference point. This paper provides an axiomatic characterization of this dependence. We proceed by imposing gradually more structure on both choice correspondences and preference relations, requiring increasingly higher levels of rationality, and freeing the decision-maker from certain types of inconsistencies. The appropriate degree of behavioral structure will depend on the phenomenon that is to be modeled. Lastly, we provide two applications of our work: one to model the status-quo bias, and another to model addictive behavior.