Does the Endowment Effect Prevail When Traders Act Strategically?

Abstract

Trading is more than a personal valuation of own property. Traders try to anticipate the WTP potential buyers have for the good they want to sell. They do not focus on the value the entitlement has for them, their personal valuation is only a reservation price. The law analyzes the Endowment Effect because it wants to protect gains from trade; most economic and psychological Endowment Effect studies by contrast are concerned with a different question: They test theories of preference formation; unlike in trading behavior they focus the participants on their entitlement to demonstrate that valuation depends on ownership and expectations. We show in this study that an experimental design that focuses the subjects' attention on their good elevates the size of the Endowment Effect and can mislead the legal debate. Our experiment provides the subjects with incentives for strategic behavior. As typical for trading, the participants can earn more if they ask for a price that exceeds their personal valuation of the good they are endowed with. The incentives shift the attention of the subjects to the potential WTP of the buyer. The results we find show that the cognitively more complex trading task weakens the owners' occupation with their entitlement and significantly decreases their loss aversion. Our findings should apply to most business transactions, as strategic behavior is very common in professional relationships. The study suggests that the Endowment Effect is likely less prominent in real markets than often suggested and that private ordering may seldom need legal protection against it.