Typical situation in any home with babies and children. The kid is playing with his toys except for one. We take the toy and start pouting. He feels he is losing something, something that gives him great value for one simple reason: it is his.

This phenomenon can be extrapolated to the adult world and, in particular, to the buying and selling of products. It is called the endowment effect, and there is a lot of psychology and scientific research involved . Let’s discover it below.

What is the endowment effect?

The endowment effect is a psychological phenomenon that occurs when people attribute more value to things solely because they possess them . That is, it is a matter of overvaluing what one already has and fearing, in a more or less rational way, losing it.

Despite the fact that things have an objective value, the subjective value that we can attribute to them is very variable depending on whether we already have it or, if not, we want to acquire it. This is very easy to understand, keeping in mind situations where economic transactions are carried out. The seller will give a higher value to the object he wants to sell in comparison with the buyer , who will want to acquire it at a low price. For this reason, in places without fixed prices like flea markets it is so common to see haggling.

On this basis, it can be understood that the endowment effect, as a bias, means that an objective analysis of the value of a given good is not made. That is why in many economic situations the intervention of a professional, such as an appraiser or manager, is necessary to give the price that the product to be sold and bought deserves.

Research on this effect

The endowment effect was originally described by the economist Richard Thaler who, together with the Nobel Prize winner Daniel Kahneman and his colleague Jack Knetsch saw this particular effect develop, as well as addressing it experimentally . The first thing that made them think about it was the particular case described below.

One person had bought a case of wine in the 1950s. Each bottle had been purchased for about $5. Years later, the person who had sold these bottles showed up, preparing to offer the new owner of the wine to repurchase the bottles at a price much higher than the original: $100 a bottle, that is, 20 times the original value. Despite the succulent offer, which implied earning 95 dollars more for each bottle, the new owner of the bottles refused to resell them .

Faced with this curious case, the Thaler group set out to experiment with this effect, this time in laboratory conditions and with cheaper objects: cups and chocolate bars.

In one of the first experiments, the participants, who were students, were divided into three groups. A group of buyers, a group of sellers and a group that had the option of buying or receiving money for a certain product.

In the group of sellers, participants had to sell their cups at prices between $1 and $9.25. In the group of buyers, they had to buy the cups by offering offers that also did not exceed $9.25. The third group had to choose between the cup and the amount of money offered to them as a bid.

Differences were seen in the value of the cup depending on the role that the participant would have had . On average, sellers sold their cups at prices close to $7, while buyers wanted to buy them at no more than $3. Those who had the option to buy the cup or an offer of money accepted around $3.

In another experiment, instead of putting money in the middle, participants were given one of two things: either a cup or a bar of Swiss chocolate. After giving each participant one of these two objects at random, they were told that they could keep what they had been given in exchange with other people in case they would have preferred to have the other object. Most of the participants, both those with the cup and those with the Swiss chocolate, chose to keep what they had been given .

What causes this phenomenon?

It is possible that a certain sentimental link has been generated to that object, which makes it difficult to detach oneself from it, since it is seen as losing a part of oneself. This is very easy to see when we shared a toy in childhood with a brother or a friend. We were afraid it would be lost or broken, and we preferred to keep it with us.

Another way of understanding it, from a more adult point of view, is the valuation we make of the value of our house in comparison with that of others. It is possible that, in terms of quality and quantity of square meters, all these houses are equal, but as a rule we attribute a higher price to our own house than to the others.

This sentimental value can be generated very quickly , and does not need to be very deep for the endowment effect to occur. In fact, this is demonstrated by research conducted by the Georgia Institute of Technology and the University of Pittsburgh, by Sara Loughran Sommer and Vanitha Swaminathan.

In this experiment, the subjects acted as both sellers and buyers. The sellers were given a pen that they could sell for values between 0.25 and 10 dollars, having also the option to buy it. The buyers could buy the pen for a price in that range or keep the money.

Before the study, half of the participants were asked to think of a past love affair that didn’t go well and write about it with the pen the researchers gave them. The other half were asked to write about something everyday, without much sentimental value.

The sellers who wrote about the love relationship tended to put a higher price on the pen , from which we can conclude that it costs us more to get rid of an object once a link associated with that object is created.

What does this have to do with loss-aversion bias?

Part of not wanting to get rid of something has to do with another cognitive bias, in this case the aversion to loss. This bias is of great importance in everyday life, given that is one of the psychological phenomena that most strongly affects all our daily decision-making .

Getting rid of something, even if it is done voluntarily, can be interpreted as a loss, and no one wants to lose. The human being is an animal that wants to retain as long as possible any property he has in his hands. For this reason, although completely conscious, when we have to decide to eliminate something from our lives, we try to avoid it, giving it a greater value than it really has, sabotaging a sale or preventing it from being shared with others.

According to Thaler, the buyer sees the acquisition of a new object as something pleasant, a need that, although not real, must be satisfied. On the other hand, the seller sees the detachment of the object as a loss, something that, in spite of being paid with money, he is not willing to feel .

What implications can this have in the commercial world?

Although we have explained the endowment effect in terms of buyers and sellers, the latter being less likely to give a low value to their product, it is true that it can be used as a beneficial business tactic for those who, at first, seem to be harmed by this psychological phenomenon.

Many stores have been able to use this psychological effect. In order to make the customers, once they have paid attention to a particular product, buy it, the persons in charge of the establishment usually let the customers touch and handle the objects they are interested in . In this way, by holding it in your hands, you may unconsciously be developing a certain emotional bond, which will make it more difficult for you to refuse to buy it.

However, one of the situations where this phenomenon is most damaging is in finance and the stock market. Many people who are involved in this world of buying and selling shares sometimes, without realizing it, cling to certain possessions, behavior which causes them to make financial mistakes.

Investing in the stock market means having to make very conscientious decisions. If among these decisions is to be too cautious, avoiding selling when the market signals that it is the right time, you will start to have losses that, ironically, is what you avoid having when the endowment effect occurs.

Bibliographic references:

  • Carmon, Z.; Ariely, D. (2000). “Focusing on the Forgone: How Value Can Appear So Different to Buyers and Sellers. Journal of Consumer Research. 27 (3): 360-370. doi:10.1086/317590.
  • Dommer, S. and Swaminathan, V. (2013). Explaining the Endowment Effect through Ownership: The Role of Identity, Gender, and Self-Threat. 39. 1034-1050. 10.1086/666737.
  • Kahneman, D.; Knetsch, J. L.; Thaler, Richard H. (1991). “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias. The Journal of Economic Perspectives. 5 (1): 193-206. doi:10.1257/jep.5.1.193.