Abstract
Endowment effect refers to the reported gaps between willingness to accept and willingness to pay. According to prospect theory, this effect is a result of the underweighting of opportunity costs. Given the high stake involved in a typical housing transaction, endowment effect is expected to have a significant influence on housing decisions. We develop a theoretical framework to study the presence of endowment effect and its role in housing decision-making process. Three hypotheses are derived and tested through a field experiment conducted in Beijing, China. Our empirical results show that endowment effect plays an important role in the formation of judgmental biases in housing decisions. Moreover, endowment effect interacts with housing cycles. Our study highlights the application of prospect theory in the housing market; thus, it not only extends existing theoretical and empirical works in this important sector, but also clarifies consumer behavior in the emerging property market of China.
Highlights
Since the publication of the seminal work of Kahneman and Tversky (1979), prospect theory has been applied to a wide range of disciplines, from finance to managerial decision making and from economics to public administration
The coefficient estimate of Dp is 34.364. This positive, significant coefficient loading indicates that the WTAWTP gap is approximately RMB 343,640, which is 8.59% of the market benchmark price used in the experiment
The sample average willing to accept (WTA) is RMB 4,265,664 and the sample average willing to pay (WTP) is RMB 4,140,140, which translates into a WTA-WTP gap that is equal to 3.14% of the market benchmark
Summary
Since the publication of the seminal work of Kahneman and Tversky (1979), prospect theory has been applied to a wide range of disciplines, from finance to managerial decision making and from economics to public administration (see Barberis 2013; Goldfarb et al 2012; Wilson 2011). The theory has been used to explain an array of anomalies that cannot be explained or even modeled using standard economic theory (SET). The long list of anomalies includes equity premium puzzle, disposition effect, endowment effect, and house money effect, to name a few. Among all the puzzles studied, endowment effect is one of the most intensively investigated and most controversial anomalies. Under SET, the price of a product is determined by its hedonic characteristics and market equilibrium. The price that a seller is willing to accept (WTA) equals the price that a buyer is willing to pay (WTP) for the same product. Empirical results show that WTA is generally higher than WTP, sometimes with as large as four times of WTP for the same product (Kahneman et al 1990). Empirical results show that WTA is generally higher than WTP, sometimes with as large as four times of WTP for the same product (Kahneman et al 1990). Thaler (1980) coined the term “endow-
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