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Reference-dependent mechanism design

Author

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  • Roland Eisenhuth

    (Epsilon Economics)

Abstract

I study revenue maximizing mechanisms in the presence of agents who are loss averse in the sense of Köszegi and Rabin (Quart J Econ 121:1133–1166, 2006, Am Econ Rev 97:1047–1073, 2007). Since the reference point is formed endogenously as an equilibrium object, the principal can influence the agents’ reference points by announcing a particular mechanism. Two specifications of reference-dependence are considered. If the agents narrowly bracket gains and losses in the good and in the money dimension separately, any optimal mechanism is all pay, and an optimal auction is an all pay auction with minimum bid; with wide bracketing of gains and losses over the entire risk neutral payoff, an optimal auction is a first price auction with minimum bid. Compared to the same environment with risk neutral agents, the minimum bid is always weakly higher with narrow bracketing and always weakly lower with wide bracketing of gains and losses. In case loss aversion is very pronounced, differentiability of the value function fails, and no familiar characterization of incentive compatibility involving the envelope theorem is available.

Suggested Citation

  • Roland Eisenhuth, 2019. "Reference-dependent mechanism design," Economic Theory Bulletin, Springer;Society for the Advancement of Economic Theory (SAET), vol. 7(1), pages 77-103, May.
    • Handle: RePEc:spr:etbull:v:7:y:2019:i:1:d:10.1007_s40505-018-0144-9
    DOI: 10.1007/s40505-018-0144-9
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    References listed on IDEAS

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    Cited by:

    1. Fu, Qiang & Lyu, Youji & Wu, Zenan & Zhang, Yuanjie, 2022. "Expectations-based loss aversion in contests," Games and Economic Behavior, Elsevier, vol. 133(C), pages 1-27.
    2. Groh, Carl-Christian & Reuter, Marco, 2023. "Mechanism design for unequal societies," ZEW Discussion Papers 23-050, ZEW - Leibniz Centre for European Economic Research.
    3. Zhe Chen, 2021. "The multidimensional procurement auctions with reference‐based utility," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(2), pages 319-325, March.
    4. Fu, Qiang & Wang, Xiruo & Zhu, Yuxuan, 2021. "Multi-prize contests with expectation-based loss-averse players," Economics Letters, Elsevier, vol. 205(C).
    5. Benkert, Jean-Michel, 2022. "On the equivalence of optimal mechanisms with loss and disappointment aversion," Economics Letters, Elsevier, vol. 214(C).
    6. von Wangenheim, Jonas, 2021. "English versus Vickrey auctions with loss-averse bidders," Journal of Economic Theory, Elsevier, vol. 197(C).
    7. Benjamin Balzer & Antonio Rosato, 2021. "Expectations-Based Loss Aversion in Auctions with Interdependent Values: Extensive vs. Intensive Risk," Management Science, INFORMS, vol. 67(2), pages 1056-1074, February.
    8. Balzer, Benjamin & Rosato, Antonio & von Wangenheim, Jonas, 2022. "Dutch vs. first-price auctions with expectations-based loss-averse bidders," Journal of Economic Theory, Elsevier, vol. 205(C).
    9. Dillenberger, David & Raymond, Collin, 2019. "On the consensus effect," Journal of Economic Theory, Elsevier, vol. 183(C), pages 384-416.

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    More about this item

    Keywords

    All pay auction; Behavioral mechanism design; Ironing; Loss aversion; Mechanism design; Optimal auctions; Reference-dependence; Revenue equivalence;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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