Expectations-Based Reference-Dependent Preferences: Evidence from the Used-Car Retail Market

Abstract

This paper empirically tests the expectations-based reference-dependent preference theory, by using a unique panel data-set on the non-negotiable daily list prices for used cars advertised by a large national dealership. It identifies a major point in car buyers' price expectation for a used car as the car's list price on the previous day. The paper finds that--- controlling for a car's actual price, its detailed attributes, the competitive environment and a rich set of fixed effects ---a positive (negative) deviation of the car's actual from the previous day's list price lowers (increases) its daily sale probability significantly more than what can be accounted for by the standard effect of the car's resulting actual price. The additional tests that the paper conducts suggest that the car buyer's price expectation, not the identified major price point in the car buyer's price expectation, is the reference point that lead to the estimated reference-price effects. Unobserved stockpiling by consumers, a major confounding factor for most estimated reference-price effects, does not confound the paper's test.

Keywords: Expectation-Based Reference-Dependent Preferences, Reference Price, Consumer Rational Expectation, Prospect Theory, Loss Aversion

JEL Classification: D03