Loss Aversion and the Endowment Effect<br />Dr. Russell James III<br />University of Georgia<br />
Our choices and our satisfaction are driven by the comparisons we make  <br />Nearby additional<br />Alternative<br />Futu...
Behavioral Economics Concepts<br />Loss Aversion; Endowment Effect; Status Quo Bias<br />Availability Effects<br />Endogen...
Two behavioral economics principles<br />1. The endowment effect<br />“Ownership creates satisfaction”<br />2. Loss aversi...
The endowment effect<br />People value a thing more once it becomes theirs <br />Ownership increases utility <br />Term or...
Students who did not get a mug reported the price they would be willing to pay to get one.<br />Students in every other se...
Students with no mugs were willing to buy them, on average, for <br />$2.25<br />Students with the mugs were willing to se...
Class B<br />Students given a chocolate bar.  At the end, given option to trade for a coffee mug.<br />Class C<br />At the...
Class B<br />Students given a chocolate bar.  At the end, given option to trade for a coffee mug.<br />Class C<br />At the...
Class B<br />10% <br />chose coffee mug<br />Class C<br />59% <br />chose coffee mug<br />Class A<br />89% <br />chose cof...
33 chimpanzees given frozen-juice popsicle or tube of peanut butter (both familiar items) and then an opportunity to trade...
Endowment effect in basketball tickets?<br />Dr. Dan Ariely, Duke University<br />http://www.youtube.com/watch?v=drEVExtrU...
Students in a non-credit photography class at Harvard picked two photos to develop then chose one to keep.<br />Group 2<br...
Both before and two days after their choice, participants asked how much they liked their photograph from 1 (not at all) t...
“The ratio of fructose to cellulose is an objective and unchanging property of apples, of course, but the experience of sw...
Students ranked 6 art posters.  Next, allowed to take home either 3rd or 4th ranked poster.  15 minutes later, they rated ...
Change in ranking of the art poster before and after they chose to take it home.<br />-.07<br />+.71<br />Group A: “if … a...
When allowed to pick their type of choice (changeable or unchangeable), people preferred:<br />66.3%<br />33.7%<br />Group...
When asked which type of choice the typical student would prefer, they believed:<br />84.3%<br />15.7%<br />Group A: “if …...
Diversification Bias <br />Endowment Effect<br />v.<br />“Our studies show that people prefer to have the opportunity to c...
Dr. Dan Gilbert, Harvard University<br />Summary<br />http://www.youtube.com/watch?v=LTO_dZUvbJA  14:19-19:05<br />
-<br />+<br />Loss Aversion<br />
Loss aversion and endowment effect<br />Once I own something, not having it becomes more painful, because it is a loss.<br...
Loss aversion and framing<br />If the same choice is     framed as a loss, 	rather than as a 	  gain, different 	   decisi...
Imagine that the US is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people.  Choo...
Imagine that the US is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people.  Choo...
Imagine that the US is preparing for the outbreak of an unusual Asian disease which is expected to kill 600 people.  Choos...
Imagine that the US is preparing for the outbreak of an unusual Asian disease which is expected to kill 600 people.  Choos...
Only the framing changed<br />600 people expected to die…<br />1/3 chance that nobody will die. <br />2/3 chance that 600 ...
Choose<br />A sure gain of $240<br />25% chance to gain $1000, and 75% chance to gain nothing<br />We are less likely to r...
Framing a gamble as a loss or a gain<br />http://www.youtube.com/watch?v=Ng9V2JneJ68  start – 5:54<br />
When an investor sells a losing stock, she is committing to the loss.  <br />Does loss aversion cause investors to hold lo...
Study: Tracking 10,000 brokerage accounts from 1987-1993 including 162,948 trades.<br />In any one year…<br />What share o...
Would investors have been better off to hold the winners and sell the losers?<br />Average 252-day gain after winners sold...
Would investors have been better off to hold the winners and sell the losers?<br />Average 252-day gain after winners sold...
Why losses hurt more<br />Is there a conflict between the core “elephant” side of the brain and the rational pre-frontal c...
Using prospect theory to pursue your goals<br />Make it a habit (status quo bias) <br />Own it (endowment effect)<br />Fea...
1. Make it a habit (Goal pursuit becomes the status quo)<br />“Creating a good habit requires much conscious effort, but o...
2. Own it <br />Ownership creates satisfaction (endowment effect). By completely identifying yourself with a future goal, ...
3. Fear its loss<br />By “owning” a future goal, immediate temptations which put that future at risk can be framed as a po...
Application question<br />Suppose you are advising a friend who wants to become a surgeon.  What practical suggestions can...
Slides by: <br />Russell James III, J.D., Ph.D.<br />Asst. Professor, Department of Housing & <br />Consumer Economics, Un...
Loss Aversion & Endowment Effect
Loss Aversion & Endowment Effect
Loss Aversion & Endowment Effect
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Loss Aversion & Endowment Effect

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A summary of research dealing with two concepts from prospect theory: loss aversion and the endowment effect by Dr. Russell James III, University of Georgia

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  • Loss Aversion & Endowment Effect

    1. 1. Loss Aversion and the Endowment Effect<br />Dr. Russell James III<br />University of Georgia<br />
    2. 2. Our choices and our satisfaction are driven by the comparisons we make <br />Nearby additional<br />Alternative<br />Future<br />Past<br />Expected<br />Current<br />Multiple Alternative<br />Relevant Observed<br />
    3. 3. Behavioral Economics Concepts<br />Loss Aversion; Endowment Effect; Status Quo Bias<br />Availability Effects<br />Endogenous Determination of Time Preference<br />Nearby additional<br />Alternative<br />Future<br />Past<br />Expected<br />Current<br />Hedonic Adaptation<br />Placebo Effect; Stereotypes<br />Multiple Alternative<br />Anchoring; Paradox of Choice <br />Peer Effects; Relative Standing<br />Relevant Observed<br />
    4. 4. Two behavioral economics principles<br />1. The endowment effect<br />“Ownership creates satisfaction”<br />2. Loss aversion<br />“People are more motivated by avoiding a loss than acquiring a similar gain”<br />Kahneman and Tversky’s “Prospect Theory” describes how people evaluate gains and losses; it includes concepts such as status quo bias, loss aversion, and the endowment effect<br />
    5. 5. The endowment effect<br />People value a thing more once it becomes theirs <br />Ownership increases utility <br />Term originated by Richard Thaler(U. of Chicago)<br />Thaler, R. (University of Chicago), 1980, Toward a positive theory of consumer choice. Journal of Economic Behavior and Organization, March, 39-60.<br />
    6. 6. Students who did not get a mug reported the price they would be willing to pay to get one.<br />Students in every other seat were given university mugs. Then reported how much they would be willing to sell the mug for.<br />What happened?<br />The students with mugs priced them higher.<br />The students with no mugs priced them higher.<br />Both sets of students priced them about the same<br />
    7. 7. Students with no mugs were willing to buy them, on average, for <br />$2.25<br />Students with the mugs were willing to sell them, on average, for <br />$4.50<br />Kahneman, D. (UC Berkley), Knetsch, J. (Simon Fraser U), Thaler, R. (Cornell), 1990, Experimental tests of the endowment effect and the Coase theorem. Journal of Political Economy, 98(6), 1325-1348.<br />
    8. 8. Class B<br />Students given a chocolate bar. At the end, given option to trade for a coffee mug.<br />Class C<br />At the beginning, offered a choice between a chocolate bar or coffee mug. <br />Class A<br />At the beginning, students given a coffee mug. At the end, given option to trade for a bar of Swiss chocolate.<br />?<br />?<br />?<br />
    9. 9. Class B<br />Students given a chocolate bar. At the end, given option to trade for a coffee mug.<br />Class C<br />At the beginning, offered a choice between a chocolate bar or coffee mug. <br />Class A<br />At the beginning, students given a coffee mug. At the end, given option to trade for a bar of Swiss chocolate.<br />?<br />?<br />Which class was most likely to choose the coffee mug?<br />?<br />
    10. 10. Class B<br />10% <br />chose coffee mug<br />Class C<br />59% <br />chose coffee mug<br />Class A<br />89% <br />chose coffee mug<br />?<br />?<br />?<br />J. Knetsch (Simon Fraser U.), 1989, The endowment effect and evidence of nonreversible indifference curves. American Economic Review, 79, 1277-1284.<br />
    11. 11. 33 chimpanzees given frozen-juice popsicle or tube of peanut butter (both familiar items) and then an opportunity to trade.<br />?<br />?<br />When initially given peanut butter <br />89% <br />Chose peanut butter<br />When initially given popsicle<br />42% <br />Chose peanut butter<br />Brosnan, S. (Emory), et al (Texas, Vanderbilt), 2007, Endowment effects in chimpanzees. Current Biology, 17, 1704-1707.<br />
    12. 12. Endowment effect in basketball tickets?<br />Dr. Dan Ariely, Duke University<br />http://www.youtube.com/watch?v=drEVExtrUgQ<br />Carmon, Ziv and Dan Ariely (2000), “Focusing on the Forgone: How Value Can Appear So Different to Buyers and Sellers,” Journal of Consumer Research, 27 (December), 360–70.<br />
    13. 13. The endowment effect in art<br />Dr. Dan Gilbert, Harvard University<br />http://www.youtube.com/watch?v=LTO_dZUvbJA8:25-13:57<br />
    14. 14. Students in a non-credit photography class at Harvard picked two photos to develop then chose one to keep.<br />Group 2<br />If you change your mind within four days, you can swap it. I’ll call at the end to double-check.<br />Group 1<br />“pick your favorite, … you won’t be able to change your mind.”<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    15. 15. Both before and two days after their choice, participants asked how much they liked their photograph from 1 (not at all) to 9 (very much)<br />Group 2<br />Change in satisfaction with picture<br />-1.8<br />Group 1<br />Change in satisfaction with picture<br />+1.3<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    16. 16. “The ratio of fructose to cellulose is an objective and unchanging property of apples, of course, but the experience of sweetness is a subjective property that increases when an apple becomes my apple”<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    17. 17. Students ranked 6 art posters. Next, allowed to take home either 3rd or 4th ranked poster. 15 minutes later, they rated their chosen poster again. <br />Group A: “if … any time in the next month, you can just let me know and we will exchange it for you.”<br />Group B: Final choice, no exchanges.<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    18. 18. Change in ranking of the art poster before and after they chose to take it home.<br />-.07<br />+.71<br />Group A: “if … any time in the next month, you can just let me know and we will exchange it for you.”<br />Group B: Final choice, no exchanges.<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    19. 19. When allowed to pick their type of choice (changeable or unchangeable), people preferred:<br />66.3%<br />33.7%<br />Group A: “if … any time in the next month, you can just let me know and we will exchange it for you.”<br />Group B: Final choice, no exchanges.<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    20. 20. When asked which type of choice the typical student would prefer, they believed:<br />84.3%<br />15.7%<br />Group A: “if … any time in the next month, you can just let me know and we will exchange it for you.”<br />Group B: Final choice, no exchanges.<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    21. 21. Diversification Bias <br />Endowment Effect<br />v.<br />“Our studies show that people prefer to have the opportunity to change their outcomes, …” <br />“but that, in fact, these opportunities inhibit the psychological processes that would otherwise have helped them manufacture satisfaction.”<br />Gilbert, D. (Harvard) & Ebert, J. (MIT), 2002, Decisions and revisions: The affective forecasting of changeable outcomes. Journal of Personality and Social Psychology, 82, 503-514<br />
    22. 22. Dr. Dan Gilbert, Harvard University<br />Summary<br />http://www.youtube.com/watch?v=LTO_dZUvbJA 14:19-19:05<br />
    23. 23. -<br />+<br />Loss Aversion<br />
    24. 24. People are more motivated to avoid a loss than to acquire a similar gain. <br />
    25. 25. Loss aversion and endowment effect<br />Once I own something, not having it becomes more painful, because it is a loss.<br />If I don’t yet own it, then acquiring it is less important, because it is a gain.<br />
    26. 26. Loss aversion and framing<br />If the same choice is framed as a loss, rather than as a gain, different decisions will be made.<br />
    27. 27. Imagine that the US is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Choose a program to address the problem.<br />A: 200 people will be saved<br />B: 1/3 chance that 600 people will be saved. 2/3 chance that no people will be saved.<br />
    28. 28. Imagine that the US is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Choose a program to address the problem.<br />72%<br />A: 200 people will be saved<br />B: 1/3 chance that 600 people will be saved. 2/3 chance that no people will be saved.<br />28%<br />Tversky, A. & Kahneman, D., 1981, The framing of decisions and the psychology of choice. Science, 211, 453-458.<br />
    29. 29. Imagine that the US is preparing for the outbreak of an unusual Asian disease which is expected to kill 600 people. Choose a program to address the problem.<br />A: 400 people will die.<br />B: 1/3 chance that nobody will die.2/3 chance that 600 people will die.<br />
    30. 30. Imagine that the US is preparing for the outbreak of an unusual Asian disease which is expected to kill 600 people. Choose a program to address the problem.<br />A: 400 people will die.<br />B: 1/3 chance that nobody will die.2/3 chance that 600 people will die.<br />22%<br />78%<br />Tversky, A. & Kahneman, D., 1981, The framing of decisions and the psychology of choice. Science, 211, 453-458.<br />
    31. 31. Only the framing changed<br />600 people expected to die…<br />1/3 chance that nobody will die. <br />2/3 chance that 600 people will die.<br />600 people expected to die…<br />1/3 chance that 600 people will be saved. 2/3 chance that no people will be saved.<br />=<br />78%<br />28%<br />≠<br />We will take great risks to avoid a loss. Reframing the same option as a loss changes the choices.<br />Tversky, A. & Kahneman, D., 1981, The framing of decisions and the psychology of choice. Science, 211, 453-458.<br />
    32. 32. Choose<br />A sure gain of $240<br />25% chance to gain $1000, and 75% chance to gain nothing<br />We are less likely to risk to get an extra gain<br />We are more likely to risk to avoid a loss<br />84%<br />16%<br />Choose<br />A sure loss of $750 <br />75% chance to lose $1000, and 25% chance to lose nothing<br />13%<br />87%<br />Tversky, A. & Kahneman, D., 1981, The framing of decisions and the psychology of choice. Science, 211, 453-458.<br />
    33. 33. Framing a gamble as a loss or a gain<br />http://www.youtube.com/watch?v=Ng9V2JneJ68 start – 5:54<br />
    34. 34. When an investor sells a losing stock, she is committing to the loss. <br />Does loss aversion cause investors to hold losing stocks longer than winning stocks?<br />
    35. 35. Study: Tracking 10,000 brokerage accounts from 1987-1993 including 162,948 trades.<br />In any one year…<br />What share of losing stocks were sold?<br />What share of gaining stocks were sold?<br />
    36. 36. Study: Tracking 10,000 brokerage accounts from 1987-1993 including 162,948 trades.<br />In any one year…<br />What share of losing stocks were sold?<br />What share of gaining stocks were sold?<br />Note the strong opposing tax incentives <br />9.8%<br />14.8%<br />Odean, T. (UC-Davis), 1998, Are investors reluctant to realize their losses? Journal of Finance, 53, 1775-1798.<br />
    37. 37. Would investors have been better off to hold the winners and sell the losers?<br />Average 252-day gain after winners sold<br />Average 252-day gain after other stocks sold, but losing stocks held<br />
    38. 38. Would investors have been better off to hold the winners and sell the losers?<br />Average 252-day gain after winners sold<br />Average 252-day gain after other stocks sold, but losing stocks held<br />+2.35% (better than market)<br />-1.06% (worse than market)<br />Odean, T. (UC-Davis), 1998, Are investors reluctant to realize their losses? Journal of Finance, 53, 1775-1798.<br />
    39. 39. Why losses hurt more<br />Is there a conflict between the core “elephant” side of the brain and the rational pre-frontal cortex “rider”. Why?<br />http://www.youtube.com/watch?v=GGQLO_iXKlU 3:06-end<br />
    40. 40. Using prospect theory to pursue your goals<br />Make it a habit (status quo bias) <br />Own it (endowment effect)<br />Fear its loss (loss aversion)<br />
    41. 41. 1. Make it a habit (Goal pursuit becomes the status quo)<br />“Creating a good habit requires much conscious effort, but once the groove has been produced the acts which make up a habitual pattern are not consciously willed.”<br />H. Keane (Australian National University), 2000, Setting yourself free: Techniques of recovery. Health, 4, 324-346.<br />
    42. 42. 2. Own it <br />Ownership creates satisfaction (endowment effect). By completely identifying yourself with a future goal, you become more attached to it<br />I claim my future<br />
    43. 43. 3. Fear its loss<br />By “owning” a future goal, immediate temptations which put that future at risk can be framed as a potential loss.<br />
    44. 44. Application question<br />Suppose you are advising a friend who wants to become a surgeon. What practical suggestions can you give to help her “own” her identity as a future surgeon?<br />
    45. 45. Slides by: <br />Russell James III, J.D., Ph.D.<br />Asst. Professor, Department of Housing & <br />Consumer Economics, University of Georgia<br />Please use these slides! <br />If you think you might use anything here in a classroom, please CLICK HEREto let me know. Thanks!<br />The outline for this behavioral economics<br />series is at rjames.myweb.uga.edu/outline.htm<br />

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