Heterogeneity of Reference Effects in the Competitive Newsvendor Problem

This paper demonstrates the mathematical equivalence between two recently proposed reference effect formulations for the newsvendor problem and then extends them to a competitive setting. The analysis of the resultant game shows that the heterogeneity of reference effects can explain multiple regularities observed in recent experimental studies of newsvendor competition. In particular, our model explains the main experimental finding that one newsvendor tends to ignore the policy of its competitor. Other experimental observations such as profit disparity, underordering in a high margin scenario, and overordering when there is no expected overflow can all be attributed to the heterogeneity of reference effects in our model’s equilibrium. In addition to explaining these observations, our model also produces a number of new testable hypotheses regarding the competitive newsvendor behavior.