Endowment Effect

I find it quite reasonable that human beings tend to put value to things that they own and numerous reasons can add to this shift of value, however when it comes in trading , endowment effect creates many inconsistencies which result in under trade due to willingness to accept and willingness to pay a certain item. Entitlements do affect value and this has been portrayed in the study of Daniel Kahneman and his colleagues titled “ Experimental Test of the Endowment Effect and the Coase Theorem” . The aim of this study was to examine an alternative explanation for buying and selling discrepancy. Series of experiments were conducted, involving real exchange of physical goods and tokens. Random allocation of buyers and sellers was assigned.
Endowment effect is a manifestation of loss aversion therefore the discrepancies between WTP and WTA occur. In order to test this effect in situation where no utilization is expected in return, several experiments have been conducted where different controls were put in induced markets ( were there was no money involved, instead tokens were given to participants) and real goods markets. The main aim of these two different markets was to isolate factors such as loss aversion since in token markets it would be irrelevant since transactions would be evaluated simply on the basis of gain or loss. Furthermore, by using these two different markets the experimenter would be able to isolate factors such as transactions costs, bargaining habits, lack of knowledge etc which would affect the discrepancies between buyers and sellers.. Before continuing with the results I must point out that 8 experiments were carried out in order to test for misinterpretations, identify the reluctance to sell or buy as well as bilateral bargaining which is contradictory explained by Coase theorem.
In all experiments similar results were obtained; in induced value markets exchange trades were done according to expectations however in goods markets usually under trading occurred due to endowment effect. Median selling price was usually over twice to that of buying price. Even in experiments when a random trading price was chosen by the experiment (with the intention to eliminate the incentive to mistake true value in order to influence price) similar results were obtained.
Even in markets when there was barter method, ( when two goods were exchanged instead of money and goods)which isolates the influence of endowment effect by ruling out income effects again the occurrence of undertrading was not eliminated.
Its interesting to point out that this study suggests an” instant” endowment occurrence. That is because participants appeared to increase the value of the goods as soon they were given to them, suggesting an instantaneous shift in reference point and value given to objects. Contrary to the assumption that preferences are independent of entitlements, the evidence of this study shows that people’s preferences depend on their reference positions, suggesting that endowment effect and loss aversion are characteristics of preferences and they can’t be eliminated by experience, training or market discipline.

Measuring Utility

The aim of this exercise was to show how much I am willing to gamble based on the amount of money that I would receive and the probability of actually getting that money.
The first graph shows the Certainty equivalence whereas the second graph shows Probability equivalence. In both graphs horizontal axis represents monetary values and the vertical axis represents utility values.
In both graphs there is a similar pattern, which shows that I am not a big gambler. I would prefer a certain amount of money rather than 50% chance of winning 1000 or 0. Furthermore, I would enter a lottery only when I would perceive a high probability of winning 1000, and only then I would be indifferent of the opportunity to have certain amount of money.