ShookRun.com

With Knowledge comes Opportunity
With Opportunity comes Success

Technical Analysis Portal Financial Analysis Value Investing Behavioral Finance Portal
>Home Page >Behavioral Finance >Endowment Effect:
[The Economist] There is a tendency to fall in love with your assets (portfolio, knowledge, etc.) and then think up all the reasons why to hold what you already own. The "endowment effect" - one of the chief tenets of prospect theory - put simply, means that people place an extra value on things they already own. Think of a favourite sweater, or your house: would you swap either for something of equal market value? Over the past decade, prospect theorists have found support for the endowment effect in scores of experiments. In one of the best-known, researchers at Cornell University began by giving university students either a coffee mug or a chocolate bar, each with identical market values. First the experimenters confirmed that roughly half the students preferred each good. After the goodies were handed out, they let the students trade: those who had wanted mugs but got chocolate (or vice versa) could swap. With barely 10% of students opting to trade, the endowment effect seemed established (you would expect 50% to have swapped, given the random allocation of gifts). Even after a short time with things of little value, ownership had overwhelmed the students' prior tastes. Dozens of other tests have produced similar results, and have produced a wave of criticism of neoclassical economics. The criticism has been taken seriously, as it should be: if the endowment effect is real, people's economic decisions are fundamentally different from what economists have assumed".
[THALER] "This pattern - the fact that people often demand much more to give up an object than they would be willing to pay to acquire it - is called the endowment effect".
[Gezgin] "The endowment effect is the asymmetry between the amount that a given individual would like to pay for a certain good and the amount that this individual would like to accept to sell the same good".
Psychology of Intelligence Analysis (CIA), Heuer, 1999
"A researcher takes a deck of 52 cards and holds one card up. Watchers pay a dollar for the chance to win $100 if that card is picked out of the deck. Keep in mind the expected payout is 1/52 - 100 = 1.92 (Las Vegas would quickly go broke with such odds). Then they are asked if they would like to sell their chances: roughly 80 percent would sell if they could, asking for an average price of $1.86. (If you could get such a price, it would be a reasonable sell. For someone who could buy all 52 chances, it would be a good purchase or arbitrage. He would make a quick 3.18 percent). Now it gets interesting. The next time, someone is allowed to pick a card out of the deck and offered the same chance, but now he has a personal attachment to the card because he touched it. Only about 60 percent of those who picked cards were willing to sell their chances, and they wanted an average price of just over $6. And when this same trick was performed at MBA schools the average sale price has been over $9. 'I know this card. I have studied it. I have a personal involvement with the card; therefore it is worth more', thinks the investor. Of course, it is worth no more than in the first case, but the psychology of 'owning' the card makes investors value it more".
Learning to Like What You Have - Explaining the Endowment Effect, Huck, Kirchsteiger and Oechssler, 2003
The endowment effect describes the fact that people demand much more to give up an object than they are willing to spend to acquire it. The existence of this effect has been documented in numerous experiments. We attempt to explain this effect by showing that evolution favors individuals whose preferences embody an endowment effect. The reason is that an endowment effect improves one's bargaining position in bilateral trades. We show that for a general class of evolutionary processes strictly positive endowment effects will survive in the long run".
What have we learnt about Loss Aversion and Endowment Effects? Still an anomaly?, Dalton, 2003
"This paper presents an insight into the theoretical and empirical literature of Loss Aversion and Endowment Effect. The definition and conceptualisation of both ideas is introduced in order to define a framework for further analysis. Their presence implies a radical change in some of the basic standard postulates of microeconomic foundation. These concepts robustly predict a divergence between Willingness to Accept and Willingness to Pay, even in a perfect-market framework and invalidate the standard assumptions of transitivity and reversibility of preferences under the neoclassical theory of consumer choice, which would imply fewer trades, inertia in the economy and sticky prices, among others. Twenty years of successive positive evidence on Loss Aversion and Endowment Effect support the theoretical implications showed in this paper. I conclude that Loss Aversion and Endowment Effects truly matter and their existence must not be taken into account just as an anomaly or puzzle, but as part of a new theory in itself, leading to new questions and challenges for future economic research".
Mispredicting the endowment effect: underestimation of owners’ selling prices by buyer’s agents, Van-Boven, Loewenstein and Dunning, 2000
"People tend to value objects more simply because they own them. Prior research indicates that people underestimate the impact of this endowment effect on both their own and other people's preferences. We show that underestimating the endowment effect and hence owner' selling prices can lead to suboptimal behavior in settings with economic consequences".
The Endowment Effect, Status Quo Bias and Loss Aversion: Rational Alternative Explanation, Dupont and Lee, 2001
"The endowment effect, status quo bias, and loss aversion are robust and well documented results from experimental psychology. They introduce a wedge between the prices at which one is willing to sell or buy a good. The objective of this paper is to address this wedge. We show that the presence of asymmetric information in a rational-agent framework can account for the endowment effect, status quo bias and loss aversion as well as psychology-based explanations proposed in the past".
Subjective Value of Information: The Endowment Effect, Raban and Rafaeli
"Value judgments about information and its value are vital for a functioning information society. Subjective valuations, formulated by individuals determine the demand for information and trading in it. Theoretically, these subjective value determinations should be influenced by ownership rights, a phenomenon coined the "Endowment Effect" in psychological study of trading situations. This study examines the Endowment Effect in the context of evaluating information. In a simple computer simulated game fifty five participants conducted a task in which they were provided opportunities to buy or sell information. The bidding mechanism was incentive compatible. Results show that, in agreement with Endowment Effect theory, people value information they own much more than information not owned by them. Our findings indicate that the ratio between Willingness to Accept (WTA) and Willingness to Purchase (WTP) for information is similar to that for market goods, and as with market goods, other than rational. Participants exhibited a strong inclination to purchase but not to sell information even though profit data suggests that the use of information had no objective benefit for profit-making. This preference is attributed to risk aversion rather than to loss aversion which is the most widely-accepted explanation of the Endowment Effect. Holding on to information and undertrade in it have strong implications for the information society".
The Endowment Effect, Kujal1 and Smith, 2003
"In this paper we show that one can observe undertrading in markets even if the WTA-WTP discrepancy is negligible. Due to underrevelation of intramarginal units very flat reported inverse supply and demand curves are obtained. As a result very small deviations in reported WTA and WTP can lead to undertrading".
Are Adults Better Behaved Than Children? Age, Experience, and the Endowment Effect, Harbaugh, Krause and Vesterlund, 2000
"We find that large increases in age do not reduce the endowment effect, supporting the hypothesis that people have reference-dependent preferences which are not changed by repeated experience getting and giving up goods".
The Endowment Effect and Expected Utility, Morrison, 1998
"The endowment effect, which is well documented in the contingent valuation literature, alters people's preferences according to a reference point established in the elicitation question. Experimental results from the literature and from a study into the value of non-fatal road injuries are shown to be evidence that an endowment effect is also at work in standard gambles".
The Endowment Effect and Repeated Market Trials: Is the Vickrey Auction Demand Revealing?, Thaler, Knetsch and Tang, 2002
The Difference between people's valuations of gains and losses has been widely observed. The Endowment Effect remains robust over repeated trials.
Experimental Evidence on the Divergence Between Measures of Willingness to Pay and Willingness to Accept: The Role of Value Uncertainty, Mueser, 1997
"One of the most robust findings in experimental analysis in economics is that subjects often display a large discrepancy between the dollar value they are willing to accept in order to sell an item (WTA) and the dollar value they are willing to pay to purchase it (WTP). We suggest that often when individuals face purchase or sale decisions, the actual private value of an object is uncertain".