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PROSPECT THEORY OFFERS POWERFUL INSIGHTS AND PROPOSITIONS INTO POLITICAL DECISION-MAKING, ESPECIALLY IN INTERNATIONAL POLITICS. EVIDENCE INDICATES THAT STATESMENT ARE INDEED RISK-ACCEPTANT FOR LOSSES. THIS WOULD HELP EXPLAIN OBSERVED PATTERNS IN BARGAINING, DETERRENCE, THE ORGINS OF WARS, AS WELL AS SUGGESTING WHY STATES ARE LESS LIKELY TO BEHAVE AGGRESSIVELY WHEN DOING SO WOULD PRODUCE GAINS THAN WHEN SUCH BEHAVIOR MIGHT PREVENT LOSSES.

We consider a simple trading relationship between an expectation-based loss-averse buyer and profit-maximizing sellers. When writing a long-term contract the parties have to rely on renegotiations in order to ensure materially efficient trade ex post. The type of the concluded long-term contract affects the buyer's expectations regarding the outcome of renegotiation. If the buyer expects renegotiation always to take place, the parties are always able to implement the materially efficient good ex post. It can be optimal for the buyer, however, to expect that renegotiation does not take place. In this case, a good of too high quality or too low quality is traded ex post. Based on the buyer's expectation management, our theory provides a rationale for "employment contracts" in the absence of non-contractible investments. Moreover, in an extension with non-contractible investments, we show that loss aversion can reduce the hold-up problem.

We present a new partial equilibrium theory of price adjustment, based on consumer loss aversion. In line with prospect theory, the consumers' perceived utility losses from price increases are weighted more heavily than the perceived utility gains from price decreases of equal magnitude. Price changes are evaluated relative to an endogenous reference price, which depends on the consumers' rational price expectations from the recent past. By implication, demand responses are more elastic for price increases than for price decreases and thus firms face a downward-sloping demand curve that is kinked at the consumers' reference price. Firms adjust their prices flexibly in response to variations in this demand curve, in the context of an otherwise standard dynamic neoclassical model of monopolistic competition. The resulting theory of price adjustment is starkly at variance with past theories. We find that - in line with the empirical evidence - prices are more sluggish upwards than downwards in response to temporary demand shocks, while they are more sluggish downwards than upwards in response to permanent demand shocks.

Does the extent of cheating depend on a proper reference point? We use a real effort task that implements a two (gain versus loss frame) times two (monitored performance versus unmonitored performance) between-subjects design to examine whether cheating is reference-dependent. Our experimental findings show that self-reported performance in the unmonitored condition is significantly higher than actual performance in the monitored condition - a clear indication for cheating. However, the level of cheating is by far higher in the loss frame than in the gain frame. Furthermore, men are much more strongly affected by the framing than women.

Studies of North Korean foreign policy are increasingly turning to the thesis advanced by prospect theory of loss aversion and reference dependence to explain its risk taking. Most of these studies focus on the post-1990s as the genesis of North Korea's risk-prone behavior. I show that Pyongyang has operated from a frame of losses since the late 1960s, due to the parallel decline of ideological unity in Soviet-North Korean and Sino-North Korean relations. In particular, from 1967 to 1968, North Korea perceived both allies to be more focused on countering each other than on jointly opposing the United States. Consequently, Pyongyang for the first time saw both Moscow and Beijing as doubtful assets in its bid for hegemonic unification. North Korea therefore stressed the role of small countries in the revolutionary struggle and launched the most violent phase of its militant strategy, emphasizing the US threat as the common enemy. The strategy was therefore in part a function of fear rather than a desire for expansion. (Asian Perspect/GIGA)