A Brief Introduction to the Endowment Effect

1. A Brief Introduction to the Endowment Effect Kam Leung Yeung Feb 19, 2013

2. Introduction • Endowment effect (EE): what is given to a person is valued more by that person than by someone who does not receive the same item • $$ • $$$$

3. Introduction • An example (Kahneman, Knetsch, and Thaler, 1990)

4. Introduction • Only 3 trades took place (out of 77 students)

5. Introduction • First identified in 1980 by Richard Thaler • Have generated research interest for over 30 years • The effect was replicated extensively across many types of goods, including mugs, candy bars, binoculars, pens, wine, and intangible goods such as hunting permits, clean air, and time • One of the most robust psychological effects • Let’s look at factors that affect the price disparity

6. Transaction demand • Definition: The motivation to complete a transaction (Mandel, 2002) • Prediction: as transaction demand increases, what happen to buy/sell price? • Owners will sell at lower price • Buyer will buy at higher price

7. Transaction demand • High transaction demand of the merchant • A. A decade ago, you purchased a case of good wine for £5 per bottle. A wine merchant is now interested in buying the case. How much would you be willing to sell it for per bottle? • B. A decade ago, a wine merchant purchased a case of good wine for £5 per bottle. He is now interested in selling the case. How much would you be willing to buy it for per bottle? • High transaction demand of the participant • C. A decade ago, you purchased a case of good wine for £5 per bottle. You are now interested in selling the case to a wine merchant. How much would you be willing to sell it for per bottle? • D. A decade ago, a wine merchant purchased a case of good wine for £5 per bottle. You are now interested in buying the case. How much would you be willing to buy it for per bottle?

8. Transaction demand • Results • EE is observed when merchants are in high transaction demand • EE is eliminated when participants are in high transaction demand

9. Market Value Heuristic What do you prefer?

10. Market Value Heuristic $2k ~ $20k / kg

11. Market Value Heuristic How much would you sell for each?

12. Market Value Heuristic • People predominantly prefer the hedonic goods BUT at the same time sell the less attractive good at higher price

13. Market Value Heuristic • Normatively speaking, one’s monetary valuation of an object should follow one’s preference • But market value heuristic significantly distort sellers’ price • Boothe, Schwartz and Chapman, 2007

14. Virtual Goods & Trading Experience • EE is not limited to goods with physical entity • Reluctance to trade is demonstrated on low-experience online gamers (De Sousa and Munro, 2012)

15. Virtual Goods & Trading Experience

16. What about Physical Possession? • Would the fact that being able to hold and examine an object affect valuation? (Reb and Connolly, 2007) • 2 (Ownership vs. no ownership) x 2 (Possession vs. no possession • Object: chocolate bar (Exp 1) and mug with university logo (Exp 2)

17. What about Physical Possession? • Results

18. What about Physical Possession? • And that is not the end of the story … • The price disparity is completely mediated by feeling of ownership, measured by “How much do you feel like you own X (even though you don’t legally own it)?”

19. Loss Aversion • While other factors are interesting, loss aversion from the Prospect Theory remains the primary explanation of the EE (Kahneman & Tversky, 1979) + -

20. Loss Aversion • Loss aversion • e.g. Prospect Theory (Kahneman & Tversky, 1979) Owner Non-owner + -

21. Loss Aversion • Cannot be loss averse • Can be loss averse • $$ • $$$$

22. Psychological Ownership • Non-owners • Owners • $$ • $$$$

23. Psychological Ownership • Preference follows ownership • Preference for letters of one’s own name (Heider, 1958) • Owning a coupon increases preference for the corresponding product (Sen and Johnson, 1997)

24. Psychological Ownership • Various behavioral evidence support augmented valuation follows psych ownership • Psych ownership, not factual ownership, explains price difference (Reb and Connolly, 2007) • Psych ownership, driven by positive valence of touch, explains price difference (Peck and Shu, 2009)

25. Morewedge et al. (2009) • Usually loss aversion and ownership are confounded: • Gain the object from • owning nothing • Do not own the object • Lose the object from • owning • Own the object

26. Morewedge et al. (2009) • Loss aversion: Sellers > Buyers • Ownership: Owners > Non-owners Non-owner buyer Owner buyer Owner seller

27. Morewedge et al. (2009) • Loss aversion: Sellers > Buyers • Ownership: Owners > Non-owners Non-owner buyer Owner buyer Owner seller

28. Yeung & Weber (2010) • No effect of factual ownership • Selling price > Buying price • Buy price for self • Buy price for other • Sell price for other • No transaction took place • Sell price for self • Buy price for other • Sell price for other

29. Q & A Thank you! Any questions?