The Endowment Effect occurs when you own something and you would sell it for a higher price than you would be willing to buy the same or similar item you don’t already own. This occurs because we establish a connection with items we possess.
The seminal example of the endowment effect occurred in an experiment with college students at Cornell by Richard Thaler. In the experiment, Group A was given Cornell coffee mugs and Group B asked to negotiate to buy the coffee mugs from Group A. An interesting thing occurred: the price demanded by the new owners of the coffee mugs ($4.50) was over twice as high as the purchasers were willing to pay ($2.25). Thus, the owners of the mugs overvalued them. This tendency to overvalue items we own has been dubbed the “endowment effect” and has been found to be pervasive.
Since the mug experiment in the 1970s the endowment effect has been seen in many different areas:
- The mug experiment was repeated with realtors and car salespeople who have a lot of experience in negotiating and found that even seasoned negotiators are prone to the endowment effect. The “owners” of the coffee mugs demanded a lot more than the buyers were willing to offer for the mugs.
- Another experiment involved pens and chocolate whereby some students were given pens and some were given nothing. The students with the pens were asked to choose between giving up their pens in trade for chocolate. 56% of the students endowed with the pens preferred to keep the pens and rejected the offer of chocolate. The students given nothing, acting as a control group, were offered a free pen or chocolate and only 24% chose a pen over the chocolate. Both groups, when surveyed later, indicated a strong preference of chocolate over the pens.
- Various studies have found that sellers of homes consider their houses to be worth about 10% more than what the market values the house.
- A study by Dan Ariely found that study subjects given NCAA Final Four tickets were only willing to sell them for about 14x more than the price that other participants were willing to pay for them.
- Traders and investors have shown a bias to hold on to stocks they own. A great question to ask yourself with respect to you investments “if I didn’t already own it, would I buy it at it’s current price given everything I know about it?”
- A trade occurred in 2015 between the Red Sox and White Sox. When fans were asked about the trade 80% of White Sox fans were against it and 100% of Red Sox fans surveyed were against the trade. Endowment effect in action!
- Even chimps have shown that they experience the endowment effect as even though chimps slightly prefer peanut butter over juice (60% vs. 40%), if they are given peanut butter they are very reluctant to trade for juice, and vice-versa.
Why Does the Endowment Effect Exist?
From The Economist: “Owen Jones, a professor of law and biology at Vanderbilt University, and Sarah Brosnan, a primatologist at Georgia State University, suspect the answer is that, in the evolutionary past, giving things up, even when an apparently fair exchange seemed to be on offer, was just too risky.”
Another potential reason: Status Quo Bias which is a preference for the current state of affairs.
IFODs of similar biases and fallacies: