Jul

18

I recently read the wiki page about The Endowment Effect.

Basically, it says the one values his possession much more than others value it.

Thaler conducted the following experiment. He randomly gave some participants a mug, which sells for $6 in a store. He then asked the ones now owning the mug to give a minimum price below which they would not sell the mug, and asked the ones not having the mug to give a maximum price above which they would not buy the mug. It turns out that the owners valued it for $5.25, while the bidders valued it at $2.75. He concluded that the very fact that the persons owned the mug made them give it a higher value.

Very interesting research. But I wonder if the conclusion is as that simple.

First, I wonder what would happen if the owners were asked to buy another mug. How would they now value it? Since it is not a critical item to have and they already own one, it is reasonable to believe that they would bid an even lower price than the bids from those who didn't own it, isn't it?

Second, what about selling short is allowed in the experiment? If the people who didn't own the mug were asked to price it if they would sell it short. I bet their price would be even higher than what the owners offered, and very likely be higher than the $6 store price.

Any input on this, please?

Gary Rogan writes:

Leo, I'm not sure it's productive to attempt to extend these "effects", and there are many of them, beyond their original definition without doing actual experiments. This particular effect seems to be as simple as "defend what's yours harder than you would attempt to get the same thing from someone else", one of the ancient evolutionary developments. Primitive (as well as advanced) animals demonstrate the same effect when fighting for territory, that's why the challenger loses most of the times. Of course someone who has a relatively useless (from their original standpoint) mug to begin with doesn't want another one. Personally I find it more interesting to think about the practical value of the original effect. In the behaviorist books it's supposed to manifest itself by "holding on to losers too long". Every time I read this I always think about whether the logical conclusion is that a rational person should always sell "losers". Sometimes they bring up the tax loss effect, and that's fair but it doesn't get to the heart of the matter. Considering this question, and all the robotic trading that goes on, how would one take advantage of this effect? 

Pitt T. Maner III writes: 

The self-storage business might be an area where this effect is felt most strongly. There is a lot of rent money being paid (by baby boomers and those who have left houses) and property used to store old things instead of buying new.

Rocky Humbert writes:

This is a fascinating subject for exploration. Being only slightly tongue-in-cheek, I wonder what effect negative real interest rates have on the willingness of people to hold onto "junk" ? To the extent that "the cost of carry" (i.e. monthly rental fees) are small, hoarding is a rational behavior. Also, there was an article in the WSJ last week discussing the effects of "clutter" on marriages and home life. Lastly, there may be a "depression-era" and "aging demographic" effect occurring here. In the situations where I've (sadly) had to empty out elderly relative's apartments, I've discovered that depression-era people hoard useless things like return envelopes from bills, archaic car and doorkeys, memorabilia from bygone days, etc. I think that there are many interesting factors at work in this trend — and there is market-related utility in thinking about them.

Jim Sogi writes:

It's really hard getting rid of one's "junk". There is a weird attachment to the stuff. Its almost painful to throw stuff away. Then there's the issue of getting rid of the junk, and then needing that item the next day. Feng Shui has some good tips on clearing the clutter. There must be some sort of hardwired effect causing one to collect stuff. Look at the bag people pushing around carts of junk.

Craig Mee writes: 

I'm with you, Jim, and in the tropics, clutter, dirt and smells brings mosquitoes, which is a very good reason to keep things clean.

On a side note. I've had a lot of trouble with mosquitoes, though I went to a friend open air villa the other evening , and when dusk hit, no mosquitoes ? I looked around and put it down to a) everything was white, walls , furniture, coverings, a well cared for garden, two ceiling fans, (some sea breeze) and importantly I thought …lights under the table we were sitting at. ie everything was clean , tidy, and white, with air.

Further, I read once, if you haven't worn clothes for a season, toss them. That's certainly worked for me.

No doubt those who make money in one particular stock , get attached, (you see it)…it clutters their mind, and they will drag any positive out of fundamentals, value, whatever to get back involved. Got to clear the clutter, or put it out of sight, to free the mind.
 

Rudolf Hauser writes:

In considering the impact of the pure psychological effect on value from ownership, one should not ignore the economic effect. The cost of the purchase is not just the purchase price of the item but the value of all the effort that went into finding the item in the first place and how difficult it might be to be able to buy it again. Then there is the risk of the replacement being defective or other problems in the acquisition thereof that might happen. One also has to consider the potential cost of needing an item and not being able to acquire its replacement in time to meet that need. As an example, I once wanted to buy a new ink eraser to replace the one that wore out. I then found that I had to run around to seemingly countless stores to find this inexpensive item –an effort countless times more expensive in opportunity cost than the price of the item itself. Needless to say, when I finally found the item, I purchased a whole box full to insure that I never would have to spend so much in search costs again for that item. Nor would I have sold those again except for much more than I paid for them.

As for the psychological impact, say one has purchased an object of great beauty at a price that subsequently appreciated considerably. The new higher price might be one at which one would not consider it prudent to buy given the overall state of one's financial resources even though it is an item one might wish one could buy. But already possessing it one has the excuse for buying it via not selling it because one already had done the deed in effect. When an item is not unique or rare and is easily replaced when a new one is needed, one would not suspect that same tendency to value the item in possession more than the same item not in possession. It would be interesting to see if this effect still persists in that case and how it compares to the former.

A stock would be of the latter type at least in small quantities. With larger quantities there is always the uncertainty as to how much such purchases might impact the price, which would the economic reason as opposed to a psychological reason. A psychological reason might be the emotional difficulty of making a decision that one is not anxious to repeat, ignoring the fact that with an investment an implicit decision has to be made every day as to whether to continue to hold or not. The difference is that to sell or purchase is an active decision whereas to hold can be a passive decision. In effect holding is also a way of putting off a decision.


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