In psychology and behavioral economics, the endowment effect, also known as divestiture aversion, is the finding that people are more likely to retain an object they own than acquire that same object when they do not own it.

This is typically illustrated in two ways. In a valuation paradigm, people's maximum willingness to pay (WTP) to acquire an object is typically lower than the least amount they are willing to accept (WTA) to give up that same object when they own it—even when there is no cause for attachment, or even if the item was only obtained minutes ago.

Examples

One of the most famous examples of the endowment effect in the literature is from a study by Daniel Kahneman, Jack Knetsch & Richard Thaler, In the years that followed, extensive investigations into the endowment effect have been conducted producing a wealth of interesting empirical and theoretical findings.

The correlation between the two theories is so high that the endowment effect is often seen as the presentation of loss aversion in a riskless setting. However, these claims have been disputed and other researchers claim that psychological inertia, differences in reference prices relied on by buyers and sellers, In this account, sellers require a higher price to part with an object than buyers are willing to pay because neither has a well-defined, precise valuation for the object and therefore there is a range of prices over which neither buyers nor sellers have much incentive to trade. For example, in the case of Kahneman et al.'s (1990) classic mug experiments (where sellers demanded about $7 to part with their mug whereas buyers were only willing to pay, on average, about $3 to acquire a mug) there was likely a range of prices for the mug ($4 to $6) that left the buyers and sellers without much incentive to either acquire or part with it. Buyers and sellers therefore maintained the status quo out of inertia. Conversely, a high price ($7 or more) yielded a meaningful incentive for an owner to part with the mug; likewise, a relatively low price ($3 or less) yielded a meaningful incentive for a buyer to acquire the mug.

Reference-dependent accounts

According to reference-dependent theories, consumers first evaluate the potential change in question as either being a gain or a loss. In line with prospect theory (Tversky and Kahneman, 1979 shows the endowment effect when the utility function is superadditive, i.e., the value of the whole is greater than the sum of its parts. Hu (2020) also introduces a few unbiased solutions which mitigate endowment bias.

Experiments in cognitive psychology have demonstrated that the endowment effect can be brought about by asymmetries in cognitive processing in judging owned and not-owned goods. A 2007 fMRI study by Knutson et al. demonstrated that the insula, an area of the brain associated with loss aversion, is stimulated when people ponder relinquishing goods they already possess. This is consistent with the hypothesis that the endowment effect entails not only ownership bias but also emotional attachment and loss anticipation neural processes. Further, the effect is also conditioned by cultural environment and personality difference in risk sensitivity.

Connection-based, or "psychological ownership" theories

Connection-based theories propose that the attachment or association with the self-induced by owning a good is responsible for the endowment effect (for a review, see Morewedge & Giblin, 2015 People have a better memory for goods they own than goods they do not own. The self-referential memory effect for owned goods may act thus as an endogenous framing effect. During a transaction, attributes of a good may be more accessible to its owners than are other attributes of the transaction. Because most goods have more positive than negative features, this accessibility bias should result in owners more positively evaluating their goods than do non-owners. presented their participants with retail prices of products, and then asked them to specify either their buying or selling price for these products. The results revealed that sellers' valuations were closer to the known retail prices than those of buyers. A second line of studies is a meta-analysis of buying and selling of lotteries. A review of over 30 empirical studies showed that selling prices were closer to the lottery's expected value, which is the normative price of the lottery: hence the endowment effect was consistent with buyers' tendency to under-price lotteries as compared to the normative price. One possible reason for this tendency of buyers to indicate lower prices is their risk aversion. By contrast, sellers may assume that the market is heterogeneous enough to include buyers with potential risk neutrality and therefore adjust their price closer to a risk neutral expected value.

Biased information processing theories

Several cognitive accounts of the endowment effect suggest that it is induced by the way endowment status changes the search for, attention to, recollection of, and weighting of information regarding the transaction. Frames evoked by acquisition of a good (e.g., buying, choosing it rather than another good) may increase the cognitive accessibility of information favoring the decision to keep one's money and not acquire the good. By contrast, frames evoked by disposition of the good (e.g., selling) may increase the cognitive accessibility of information favoring the decision to keep the good rather than trade or dispose of it for money (for a review, see Morewedge & Giblin, 2015). found that prospective mug buyers tended to recall reasons to keep their money before recalling reasons to buy the mug, whereas sellers tended to recall reasons to keep their mug before reasons to sell it for money.

Evolutionary arguments

Huck, Kirchsteiger & Oechssler (2005) and that the endowment effect is moderated by culture (Maddux et al., 2010 Hanemann (1991)

Implications

Implications regarding the endowment effect are present at both the individual and corporate level. Its presence can cause market inefficiencies and value irregularities between buyers and sellers with similar consequences at smaller or upscaled transactions.

Individual

Herbert Hovenkamp (1991) Similarly, another study that is focused on the Strategic Reallocations for Endowment analyses how it is the case that economics's agents welfare could potentially increase if they change their endowment holding.

Further to this, the endowment effect has been linked to both economic and psychological impacts of various scale. For example, often individuals refuse the sale of their house or upscale their expected value simply due to their emotional attachment and effort poured into it. This means they might either stick with a property which causes greater inconvenience to alternatives or have an increased level of difficulties associated with its sale. Here consumers are often given a sense of ownership over what the business possesses thereby unlocking the cognitive bias.

Free trials

By offering free trials to select services, business not only expand the number of users reached, but during this trial period they also give consumers a sense of ownership. Consumer's psychological perception thus makes them more reluctant to part with the service when the trial ends, thereby increasing the quantity of subscribers.

Free return

This marketing strategy makes consumers more likely to purchase the product due to the perception of it being more endowing. However, once purchased, customers are less inclined to return it even if a level of dissatisfaction was experienced. Fashion and furniture businesses largely rely on haptic imagery to sell their products. While they do not necessarily offer customers to use their products they create an image of what could be, by either offering online viewing adjustments or appealing to ones sense of imagination.

  • Wright, Josh (2005). The Endowment Effect's Disappearing Act, and (2009) What's Wrong With the Endowment Effect?
  • The "Mystery" of the Endowment Effect, Per Bylund, December 28, 2011
  • What Explains Observed Reluctance to Trade? A Comprehensive Literature Review