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Expectations-Based Loss Aversion May Help Explain Seemingly Dominated Choices in Strategy-Proof Mechanisms

Bnaya Dreyfuss, Ori Heffetz, Matthew Rabin

NBER Working Paper No. 26394
Issued in October 2019
NBER Program(s):Economics of Education Program, Public Economics Program

Deferred Acceptance (DA), a widely implemented algorithm, is meant to improve allocations: under classical preferences, it induces preference-concordant rankings. However, recent evidence shows that—in both real, large-stakes applications and experiments—participants frequently play seemingly dominated, significantly costly, strategies that avoid small chances of good outcomes. We show theoretically why, with expectations-based loss aversion, this behavior may be partly intentional. Reanalyzing existing experimental data on random serial dictatorship (a restriction of DA), we show that such reference-dependent preferences, with a degree and distribution of loss aversion that explain common levels of risk aversion elsewhere, fit the data better than no-loss-aversion preferences.

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Document Object Identifier (DOI): 10.3386/w26394

 
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