The Perks and Quirks of Endowment Bias

The Endowment Effect is a rapid test that can show you how much you value your ego. Really. A famous, well-replicated social experiment has shown this. If you receive a mug for free and someone asks you how much are you willing to sell it for, you are most likely to price the mug at a higher value than the buyer. Somehow, your tendency to value the goods you own at a higher price reveals an underlying bias known as the Endowment Effect.

Endowment effect (or endowment bias) just proves that, hey, “because I own this mug, it must have gained more value than before”, it’s an ego massage.  

A wide range of experiments has been done on how far we tend to resort to this bias—from sports cards, lottery receipts, basketball tickets, wine bottles, and a bunch of other stuff. And each time, the results often yield the owner's minimum selling price exceeding the buyer's maximum buying price by a factor of 2 or 3.

Behavioral researchers have long assumed Loss Aversion as the engine behind the Endowment Effect. Because we don’t like losing stuff more than gaining, it follows that before losing the thing that we own, we have to put up some high barrier—which is often higher than the buyer’s ladder.

The problem with this assumption is that Loss Aversion does not adequately explain auctions, bargain sellers, pawnshop sellers, eBay bidders/sellers (which agree on very subjective price points). In these settings, people tend to still show signs of endowment bias even if they don’t feel averse to losing their stuff.

Why is that?

A better theory to explain this behavior can be found in Ray Weaver’s and Shane Frederick’s research in 2012. According to Weaver and Frederick, loss aversion is not the evil twin of the endowment effect; it’s quite simply our aversion to feeling duped.

Their basis is the perception of price. Generally, there are two price points that buyers/sellers refer when valuing their stuff:

First, they don’t want to sell their stuff for less or buy for more than their subjective value.

Second, they don’t want to sell their stuff for less or buy for more, than the objective market price.

If the price points exceed their valuations or the market’s, they fear they’ve been handed a bad deal.

From this view, it seems that the endowment effect isn’t so bad at all. It’s just a careful estimation.

But it quickly becomes a bias behavior when the stuff we’re talking about are things that have sentimental value, or something we are proud to possess. Especially when we think that the stuff we possess are things that few people have—like a painting, a vintage wine, or a collector’s item.

So when the endowment effect kicks in, we would overvalue our possessions to the point that there is a large gap between our price and the buyers. The result is that we wouldn’t make a sale.

A lot of stuff that isn’t sold on eBay is a result of endowment bias. In the same way, people who walked out from pawnshops with their unsold goods have likely overvalued their stuff.

Many stock traders have gone bust because they’ve held too long and too high for their shares. We can potentially miss out on a great deal waiting for our estimation of a good deal.

To prevent endowment bias, you just need to do what professional poker players do—or listen to that Kenny Roger’s song—know when to hold, when to fold, when to walk away, and when to run.