Edoardo Grillo (Princeton University)

“Reference Dependence, Risky Projects and Credible Information Transmission”

abstract

We consider the interaction between an informed agent (A) who can make announcements concerning the information she has and an uninformed agent (B) who has to decide whether to start a project or not. We study the role that reference dependence and loss aversion may play in determining the credibility of A’s announcement and we show that they may give rise to credible information transmission. This happens because in our model inaccurate information have two effects: they lead B to choose the action A prefers in the short run, but they also generate unrealistic expectations that, through the effect on reference point, may induce B to take long run actions that hurt A. This phenomenon is not possible in a model where the uninformed agent is a standard expected utility maximizer. We further investigate the role that reference dependence can play in settings in which A can write verifiable contractual clauses to reinforce the credibility of her announcements. We show that contractual clauses may lead to credible information transmission, but that this involves monetary transfers that may vary non-monotonically with the degree of loss aversion.