Expectations-Based Loss Aversion May Help Explain Seemingly Dominated Choices in Strategy-Proof Mechanisms
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.
A version of this paper constituted Dreyfuss’s MA thesis at The Hebrew University of Jerusalem. We thank Ned Augenblick, Alon Eizenberg, Zoë Hitzig, Shengwu Li, Alex Rees-Jones, Assaf Romm, Charlie Sprenger, the JESC-lab group and especially Matan Gibson, Ofer Glicksohn, Guy Ishai and Kobi Mizrahi, and seminar/conference participants at the Hebrew University, UCSB, University of Utah, UC Berkeley, and BEAM for invaluable comments. This research project was supported by the I-CORE program of the Planning and Budgeting Committee and the Israel Science Foundation (grant no. 1821/12). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research