A tri-reference point theory of decision making under risk

Area of Science:

• Behavioral Economics
• Decision Theory
• Cognitive Psychology

Background:

• Traditional decision-making models often use a single reference point (e.g., status quo or gain/loss).
• Understanding how multiple reference points influence risk perception and choice is crucial.
• Existing theories like prospect theory may not fully capture complex reference point interactions.

Purpose of the Study:

• To introduce and formalize the tri-reference point (TRP) theory for decision-making under risk.
• To empirically test key predictions of the TRP theory regarding minimum requirements (MR), status quo (SQ), and goals (G).
• To investigate the psychological impact and weighting of different reference points on risk preferences.

Main Methods:

• Mathematical formalization of TRP theory, including assumptions and value functions.
• Empirical testing of TRP predictions using both explicit and implicit reference points.
• Analysis of choice preferences and risk-taking behavior across different gamble distributions relative to reference points.

Main Results:

• Decision-makers consider both goals (G) and minimum requirements (MR), with MR receiving greater weight, indicating failure aversion.
• A double-S shaped value function with three inflection points captures observed risk preferences.
• The presence of MR significantly shifted choices toward risk aversion, even for gambles well above MR.

Conclusions:

• TRP theory provides a more comprehensive framework than single-reference point models for understanding decisions under risk.
• Failure aversion is a significant factor influencing risk preferences, alongside loss aversion.
• TRP theory offers practical guidelines for individual and organizational risk management.