Reference dependence in iterative choices

Valuation of goods often proceeds from a series of hypothetical pairwise choices. We examine reference dependence on the outcome of such evaluations in a large-scale study in which respondents make a series of choices between areas that differ on cost of living and the quality of lakes and rivers. We uncover three substantial reference effects. First, we find that respondents’ choices are altered by being told the national value of water quality. For these people, consistent with prospect theory, changes in water quality below the 65% referenced national standard are treated as losses and given more weight while identical changes above 65% are treated as gains and given less weight. Second, we find that the sequence of iterative choices matters in a surprising way. The iterations proceed by encouraging switching either by degrading the chosen alternative or improving the item chosen. We show that improving the item not chosen produces the greatest switching, a result consistent with prospect theory, but only if the item changed in the iteration becomes the reference alternative. Finally, we find a strong starting reference effect. That is, we show that the trade-off in the first choice reflected in the change in cost of living divided by the change in water quality has a substantial impact on the final valuation. We assess the relative impact of these three reference effects and suggest ways of dealing with them for valuation of non-market goods.