| The most widely used decision model for choice under uncertainty is the Expected Utility (EU) model developed by von Neumann and Morgenstern (1944). In spite of its popularity, the predictions of the EU model have often been found to be inconsistent with observed behaviour, in both experimental research and field studies. The systematic and persistent nature of these anomalies has undermined the reliability of the EU model.;Research in cognitive psychology has recognized that the decision process under uncertainty is very complicated. It may involve several phases like editing, framing, and evaluation (Kahneman and Tversky, 1979). The notion of bounded rationality recognizes the limited capacity of information processing. Therefore, in making decisions, people often use heuristics to simplify the task. The findings in field studies and experimental research suggest that a commonly used heuristic for decision-making is the adoption of a reference point. A reference point model also acknowledges the endowment effect and the status quo bias in reaching a decision. Furthermore, a reference point model can capture the framing effect when the context of the problem will influence the selection of the reference point.;The reference point model developed in this research is similar to the skew-symmetric-bilinear (SSB) utility function (Fishburn, 1982) and regret theory (Bell, 1982; and Loomes and Sugden, 1982). The reference point model will use a stationary anchor, instead of random pairwise comparison between alternatives in the SSB utility function and regret theory. Consequently, transitivity is preserved in the reference-specific preference orderings. The research shows that reference point theory can accomodate various anomalies inconsistent with the EU predictions. The isolation effect, the response mode effect, and the preference reversal phenomenon can be predicted by switching reference points. When reference point is used as heuristic and editing is involved in the decision-making process, reference point theory can explain the common consequence effect, the common ratio effect, and the reflection effect. |
