Famed psychologists Daniel Kahneman and Amos Tversky are best known for developing prospect theory, a key contribution to the field of economics. Prospect theory, which was developed over the course of thirty years of extensive research, offers an explanation for typical patterns of risk and uncertainty management.1 The concept of a reference point is a principal feature of this theory.
Prospect theory suggests that when people are presented with alternatives, each with their own probability of gains and losses, they will assess the utility – the potential benefits – of each possible outcome, relative to a reference point – for example, how much money they currently have. They are not evaluating the absolute utility of each outcome, but rather the relative utility.2 The theory of loss aversion posits that people would rather take a risk to avoid a loss than take an equivalent risk in order to gain something of equivalent value.3 We depend on reference points in order to classify the potential outcomes of different options as gains or losses.4
An example of the role of reference points in prospect theory comes from a study conducted by Idris Adjerid and their colleagues, the results of which were published in 2013 in a paper titled “Sleights of privacy: Framing, disclosures, and the limits of transparency”.5 When people are presented with online privacy notices, they compare the level of protection offered to the level of protection offered by privacy notices that had previously been presented. Say, for example, a group of people in an online study are presented with privacy notice A, and then asked to answer a series of questions, while another group of people are presented first with privacy notice B, which offers a higher level of protection than privacy notice A, and then are subsequently presented with privacy notice A and asked to answer the same questions. People in the first group will disclose more information after seeing privacy notice A than will those in the second group. This is because the people in the second group are using privacy notice B, which is more protective, as a reference point and therefore view privacy notice A as insufficient and too risky.