Investor Reference Points: An Investigation using Experiments and Asset-Pricing Models

It is widely acknowledged that reference points play an important role in decision-making and that the study of reference points has application to decisions taken in a wide range of areas within Management, Marketing and Sports Analytics. Within the realm of Finance, reference points have been incorporated into models that are designed to capture the behaviour of both buyers and sellers of financial assets. Typically, the reference point within these models is assumed to be the purchase price of an asset and is not thought to move in line with the price of the asset. Our aim in this thesis is to investigate the role of reference point adaptation by investors. Specifically, we examine if prior price movements can influence the reference point of participants. Our study should be of interest, both in the academic field of reference points and more specifically in the area of reference points within financial models. We use both experiments and classical empirical methods within the thesis, utilising the advantages of both methods. Experiments are used to test for reference point adaptation within controlled conditions. We undertake two different experiments, which measure reference point adaptation across either a single chart, or across 60 months within a chart. Then we test the external validity of our findings, using three different market data models. Each of the market data models use reference points to predict mispricing in shares. The use of both experiments and market data testing within a single study is rare within the academic literature and is a key competitive edge of our approach. Our results have implications both for academics interested in reference point adjustment and investment professionals who wish to study how reference points cause mispricing in markets. The distortions in market prices caused by reference points, which we demonstrate using three different market data models, lead to profitable arbitrage opportunities which could be capitalised upon by Investment Managers.