The endowment effect may largely reflect “adaptively rational” behavior on the part of both buyers & sellers, given their beliefs about relevant markets, rather than any ownership-induced bias or change in intrinsic preferences

Achtypi, E., Ashby, N. J. S., Brown, G. D. A., Walasek, L., & Yechiam, E. (2021). The endowment effect and beliefs about the market. Decision, 8(1), 16-35. http://dx.doi.org/10.1037/dec0000143

Rolf Degen's take: https://twitter.com/DegenRolf/status/1348992873912479744

Abstract: The endowment effect occurs when people assign a higher value to an item they own than to the same item when they do not own it, and this effect is often taken to reflect an ownership-induced change in the intrinsic value people assign to the object. However recent evidence shows that valuations made by buyers and sellers are influenced by market prices provided for the individual products, suggesting a role for beliefs about the markets. Here we elicit individuals’ beliefs about whole distributions of market prices, enabling us to quantify whether or not a given transaction constitutes a “good deal” and to demonstrate how an endowment effect may reflect such considerations. In a meta-analysis and three laboratory experiments, we show for the first time that ownership has no effect on beliefs about either: (a) the quality of the item or (b) the appropriate market price for the item. Instead, we show that sellers demand a price for the item that matches their beliefs about the item’s relative quality and the distribution of market prices in the market. Buyers, in contrast, offer less than what they believe the appropriate market price is. Thus, we argue that the endowment effect may largely reflect “adaptively rational” behavior on the part of both buyers and sellers (given their beliefs about relevant markets) rather than any ownership-induced bias or change in intrinsic preferences.

Keywords: endowment effect, valuation, ownership, market price, good deal

General Discussion

We explored the hypothesis that valuations of buyers and sellers may reflect their differing beliefs about the broader market of prices and products (Brown, 2005; Isoni, 2011; Weaver & Frederick, 2012). Specifically, we developed a novel quantification of deal goodness in terms of the rank-based difference between the “appropriate” price (generated by the quality matched process) and the WTA and WTP monetary valuations. In terms of this good-dealness consideration, the endowment effect emerges because, given they will typically lack any strong desire to possess the object, buyers are only willing to purchase a product if they get a very good deal (relatively low market price given products’ quality). Sellers valuations, on the other hand, should correspond closely to the expected market price for a given good. Indeed, we show that sellers are willing to accept prices that correspond to their beliefs about what the given product should cost in the broader market. Buyers do not differ significantly from sellers in their beliefs about the market but are willing to pay substantially less than they believe the product costs in the market.

In Experiment 1, using a distribution elicitation task, we set out to determine whether beliefs about the distributions of market prices for a given class of consumer products (here water bottles) differ as a function of ownership status. We found no evidence of such a bias (see also Experiment 3 in Walasek, Yu, & Lagnado, 2018). In addition, we demonstrated that while both buyers and sellers value the object at less than its market price, buyers have a strong tendency to provide WTP amounts that correspond to the lowest end of the market price distribution. In Experiment 2, we replicated these findings and additionally found that owners and nonowners do not differ in their estimates of the product’s quality (in terms of how its quality ranks among other similar products). Moreover, owners and nonowners produced similar estimates of the product’s actual market price. Using a wide range of consumer products, valuations of sellers in Experiment 3 were closer to the estimated market price of each good than valuations of buyers were.

Our results are comparable to the findings reported in studies of the endowment effect for risky and ambiguous gambles. Sellers, not buyers, tend to set the minimum selling price to be close to the actual objective worth of a risky asset (Yechiam, Abofol, & Pachur, 2017; Yechiam et al., 2017). Although in the present study we cannot make any statement about the ideal price of a consumer good for each person, our findings show that sellers’ valuations align with their perception of what the item should be worth as a product in the marketplace. Our results therefore extend previous efforts beyond the context of gambles.

Our study builds on and extends recent accounts suggesting that the endowment effect is at least in part driven by the considerations of what constitutes a good deal. This account differs from traditional explanations of the endowment effect in several key respects. Most importantly, unlike many accounts based on concepts such as loss aversion, our account does not assume ownership-induced changes in people’s valuations of the object if such valuation is defined in terms of underlying preferences (rather than, e.g., the profit that could possibly be made by selling it). In this respect, our account is similar to that of Isoni (2011). However, unlike Isoni, we do not need to assume “bad deal aversion” in that we do not require any asymmetry in hedonic impact of under- and overpaying. Of course, we do not discount the possibility that ownership status can influence people’s valuations via mechanisms such as asymmetric attention (Ashby, Walasek, & Glöckner, 2015; Carmon & Ariely, 2000) or psychological ownership (Walasek et al., 2015; Walasek et al., 2017).

It is important to note that our results do not provide direct causal evidence for the relation between perceptions of good dealness and valuations of owners and nonowners. Instead, our account is mostly descriptive—we illustrate how valuations of buyers and sellers map onto participants’ beliefs about the product and the broader context of the consumer market. By doing so, we can show patterns of valuations that fit well with recent theoretical and experimental developments in which the behavior of buyers and sellers is largely dictated by their consideration of how to secure (avoid) a good (bad) deal. Past work and our own results thus align with a simple pragmatic explanation of the endowment effect. When participants come to the lab and are offered a chance to purchase some consumer good, most people do not want it, even at a substantial discount (relative to its potential market value). Sellers on the other hand, value the product appropriately given on their knowledge of the market. If this account correctly captures people’s reasoning, there is no need to invoke any psychological biases, such as loss aversion, to explain the endowment effect. We do not provide direct evidence against loss aversion explanation of the endowment effect but rather offer an alternative explanation of the valuation gap. The conclusion of most researchers (i.e. that the endowment effect reflects loss aversion) is based on the assumption that participants’ valuations reveal their true underlying preferences, which are in turn assumed to be uncontaminated by strategic considerations or beliefs about the market. This assumption stands in contrast with the finding that even in an incentivized experiment, many buyers and sellers admit that their valuations were motivated by “seeking a good deal” or a consideration of a “reasonable or compromise price” and “selling cheaply to make sale likely” (for sellers, Brown, 2005). Further research is necessary to show how buyers and sellers might be differently influenced by their beliefs about the broader market. One potential extension of the present study would be to manipulate beliefs about the market. Using products that are less known among the participants, we would expect that valuations of sellers would be much more influenced than those of buyers by such a manipulation. The evidence presented by Weaver and Frederick (2012) is consistent with this prediction. Although our results do not disprove a role of loss aversion in the endowment effect, our alternative account suggests that the assumption of loss aversion is not necessary. We therefore suggest that explanations of the endowment effect in terms of loss aversion be discounted until and unless specific evidence for loss aversion is forthcoming. We argue that our account is parsimonious because it explains both the endowment effect and sellers’ greater sensitivity to observed market prices in terms of the difference between buyers’ and sellers’ beliefs about relevant markets without requiring the additional assumption of loss aversion (as postulated for instance by Weaver & Frederick, 2012).

In Experiments 2 and 3, we found that buyers and sellers did not differ in terms of how they rated the products on quality and benefit, respectively. These findings appear difficult to reconcile with the idea that endowment effect emerges, at least in part, due to the sense of emotional attachment that develops among owners (Shu & Peck, 2011; Walasek et al., 2015). Indeed, participants who own an object have been shown in other studies to rate an object more favorably than nonowners—a phenomenon known as the mere ownership effect (Beggan, 1992). One plausible explanation for our results is that our design did not provide owners with enough opportunity (or reason) to develop any meaningful sense of psychological ownership. Even in the case of Experiment 2, where owners had more contact with the product than nonowners, such a short duration of ownership could simply be insufficient to generate any special bond between an individual and a consumer good.

The idea that perception of good dealness is an important influence on stated buying and selling prices has wider implications concerning the use of incentive compatible procedure like the BDM (Becker et al., 1964) to elicit true valuations. If the amount that people are willing to sell or buy an item for reflects market considerations relating to appropriate prices for an item of that quality, rather than or as well as an individual’s desire to possess the object, the valuations obtained using BDM-like procedures cannot be interpreted as unbiased measures of underlying preferences. At the very least, our results suggest that sellers and buyers engage in the valuation task differently, with sellers intuitively considering broader context of the market in making their decisions.