ENDOWMENT EFFECT/

TROPHY EFFECT

SUBMITTED BY:
GROUP 2
PAVAN AGRAWAL C004
SONALI AMIN C005
SUMIT JAKHAR C026
AKSHIT MAHAJAN C036
MANAN SHAH C053
SANDHYA VENKITAKRISHNAN C064
THE ENDOWMENT EFFECT
The endowment effect describes a circumstance where an individual values something
that they already own more than something that they do not yet own. the perceived
greater value occurs because the individual possesses the object in question.
Investors, therefore, tend to stick with certain assets because of familiarity and comfort,
even if they are inappropriate or become unprofitable. The endowment effect is an
example of an emotional bias.

• Term originated by Richard Thaler (U. of Chicago)

• WTA for a good people own is higher than WTP
• People value a thing more once it becomes theirs
• Ownership increases utility
• “ownership, and not loss aversion, causes the endowment effect
Students in every other Students who did not
seat were given get a mug reported the
university mugs. Then price they would be
reported how much willing to pay to get
they would be willing to one.
sell the mug for.

What happened?
a) The students with mugs priced them higher.
b) The students with no mugs priced them higher.
c) Both sets of students priced them about the same
RESULT

Students with the mugs Students with no mugs

were willing to sell them, were willing to buy
on average, for them, on average, for

$4.50 $2.25
 Class A Class B Class C
At the beginning, Students given a At the beginning,
students given a chocolate bar. offered a choice
coffee mug. At At the end, between a
the end, given given option to chocolate bar or
option to trade trade for a coffee mug.
for a bar of Swiss coffee mug.
chocolate. ?

?
?
 Class A Class B Class C

89% 10% 59% chose coffee mug

chose coffee mug chose coffee mug

?
?
?
DETERMINANTS OF ENDOWMENT EFFECT
The main determinant that influences the gap between WTA and WTP are :
 The availability of substitutes for a particular good
 The mood of the subjects
 The source of the money which is being spent
 Amount of effort that has been put in to attain an object (Trophy Effect)
- Participants who had received an object as a reward have higher WTA
- Implies that people overvalue “trophies” they had to work for in order to obtain them
 Others
- The perceived illegitimacy of the transaction
- Bargaining abilities
 EVIDENCE SUPPORTING ENDOWMENT EFFECT
STUDY 1
• A series of experiments were conducted by Kahneman et al. to demonstrate that
endowment effect persists even in market settings with opportunities to learn.

• Experiment 1 (n = 44): Sellers were given tokens of different values which were equivalent to actual money.
• Sellers could either sell the tokens to buyers for a price ranging from $0.25 to $8.75 in steps of $0.50, or could
cash it in for the sum of money it represented.
• The ratio of actual to predicted volume was 1.0 over the 3 periods.
• Next, tokens were replaced with mugs/pens and same experiment was conducted
• The median selling prices in the mug and pen markets were more than twice the median buying prices

• Experiments 2, 3, 4 (n = 38): Same as experiment 1, except the item was a pair of folding binoculars in a
cardboard frame, available for $4.00.
• In experiments 3 and 4, subjects were asked to provide minimum selling prices or maximum buying prices. All
3 experiments showed results similar to experiment 1
STUDY 2
A series of experiments were conducted by Buhren et al. to determine the positive effect of labour on
people’s valuations for a good and to disentangle the different components of the trophy effect
• Baseline/control group (n = 18): Subjects were given a pen which they could sell (sellers) or were asked
to purchase the pen (buyers). The participants were then asked to enter a price between €0 - € 5 at
which were willing to buy/sell the pen.
• Trophy group (n = 20): Students participated in a mathematics quiz and top 10 performers received a
pen as a reward. Those with a pen became sellers and others buyers of the pen.
• Work group (n = 16): Subjects in this group also had to solve a mathematics quiz. However, instead of
the top 10 performers, all presumptive sellers were remunerated with a pen for their efforts,
irrespective of their performance.
• Lottery group (n = 22): Participants in this group took part in an explicit lottery in which they had a 50%
chance of winning a pen by drawing a ticket.
Trophy Effect Reverse Trophy Effect

Work Group Lottery Group

STUDY 2 Results
IN THE FINANCIAL WORLD
EXAMPLE 1: PORTFOLIO MANAGEMENT/INHERITANCE
PROSPECT THEORY
• Disagrees with Theory of Expected Utility - a rational investor would evaluate all investment options
• EUT also says – Investors do not have any ‘emotional attachment’ to current portfolio of investments
• Prospect Theory states - investors tend to exhibit a strong attachment to the status quo
• Makes people demand a much higher price for their assets than the value they would be prepared to pay for them
• Endowment Effect is a cognitive illusion

THE EXPERIMENT
• 226 individuals researched – drew THE VERDICT
PORTFOLIO PORTFOLIO lots for portfolio • % REAL ESTATE IN PORTFOLIO 1 GREATER
1: 2 & 3: PORTFOLIO THAN OTHER PORTFOLIOS
• Before Round 1: Participants can buy
93.3% Real WHOLLY 4: • PORTFOLIO 3 HAD GREATER PROBABILITY
Estate INVESTED IN ONLY CASH sell assets w/o transaction costs
6.6% Cash SHARES (recompose portfolio) • CONCLUSION: the portfolio factor
• Experiment asked following questions-- influenced the profitability and the
PORTFOLIO 1. Are decision makers affected by composition of the different portfolios
PORTFOLIO
2:
3: the cognitive illusion of the • The influence of the initial portfolio =
MUCH Endowment Effect? higher attachment to given status quo
PERFORMA
HIGHER
NCE BELOW 2. Does the managers’ initial • In the simulation, the participants believed
PERFORMA
AVERAGE portfolio influence the final that the initial portfolio was the point of
NCE
profitability of their investments? reference to which they “should” return.
IN THE FINANCIAL WORLD
EXAMPLE 2: INDIAN IPO
RANDOM ASSIGNING OF IPO LOTTERY SHARES
• PAPER DISCUSSES - winners of randomly assigned initial public offering (IPO) lottery shares are significantly more likely to
hold the shares of the company than lottery losers 1, 6, and even 24 months after the lottery allocation.
• Evidence derived from 1.5 Million Indian Stock Investors

1. STUDY 2. HYPOTHESIS 3. RESULTS

• Real Market Participants assigned
objects
• Relationship between market
experience and endowment effect
analysed - No. of IPOS Allotted in
past 10 years
• Found strong negative correlation
between this experience measure
holdings between lottery winners and
losers
• the authors rejected the idea that
more experienced market participants
exhibited the endowment effect
anomaly more strongly.
1. Participants should have same
preferences before and after
shares are allotted
2. Thus, while lottery losers do not
have the opportunity to buy the
shares at the issue price, once the
stock begins to trade, both winner
and loser groups have equal
opportunities to trade the stock
3. If endowment effects were
important, however, there would be
a divergence in the behaviour of the
randomly chosen winners and
losers.
• Winners of these IPO lotteries were
substantially more likely to hold the
randomly allocated IPO shares for many
months and even years after the
allocation
• On average, 56.4% of IPO winners held
the IPO stock at the end of the month,
while only 1.4% of losers held the stock
• 6 months after the lottery assignment the
gap decreased slightly, to 46.6% of
winners holding the stock and 1.6% of the
losers holding the stock
• even 24 months after the random
assignment winners were 35% more likely
to hold the IPO stock than losers
IN THE FINANCIAL WORLD
EXAMPLE 3: AUSTRALIAN STOCK MARKET
ORDER PLACEMENT OF STOCK TRADERS ON AUSTRALIAN STOCK EXCHANGE
• Asymmetry in Pricing - sellers appear to value their own shares higher than buyers independent of current market price
• Asymmetry greater in private client trading – sophisticated investors are less affected by asset ownership
• Increase in Day-Traders – increasing gap between ask-bid quotes

1. STUDY
• TWO GROUPS: “retail”
broker orders,
conducting primarily
private client trading,
and “institutional”
broker orders, trading
primarily for institutions
and themselves
• Compare placement
behaviour of a specific
class of traders
2. HYPOTHESIS
1. The study tests whether on
average, buy orders would be
closer to the market than sell
orders in both rising and falling
markets
2. If experienced or otherwise
sophisticated traders are least
subject to the endowment effect,
the study expected their ask
quotes to cluster more closely to
the market and not to differ on
average by significantly more
than their bids.
3. RESULTS
• Asks were placed on average 23.4%
further away from the market than
bids (value-weighted ratio) and
57.1% away from bids (simple
average)
• Bids were placed an average of
0.291% away from the current best
bid (value-weighted), while asks
were placed an average of 0.359%
away from the current best ask
• This proves the asymmetry
between retail investors ask and
institutional investors.
 PRACTICAL APPLICATION OF ENDOWMENT
EFFECT
IKEA EFFECT
• Individuals usually tend to pay higher
for objects that they have themselves
created, or have contributed towards
their construction/design.
• Difference from Trophy Effect - IKEA
effect is directly performed on the
valued object itself
• AS A MARKETING TOOL –
• 1950s – Ready Made Cake Mixes
• Not accepted initially – insulting
to ability of female cooks
I-DESIGNED-IT-MYSELF EFFECT
• Similar to IKEA EFFECT
• Seen in Mass-customisation
• increase in value attributed by an
individual to self-designed objects which
arises from the fact that he/she feels like
the creator of the object
• AS A MARKETING TOOL –
• Widely used – customers given
option to design their own products
• NikeID – Allows customisation of 11
shoe parts, available in 18 colors
NOT-INVENTED-HERE EFFECT
• extension of the trophy effect
• when managers avoid buying or implementing
best-practice products or ideas, simply because
they were developed elsewhere even if they
are superior to existing products or ideas
• AS A CREATIVE TOOL –
• Employees who are awarded “winners” tend
to deliver better work results, whereas
those who do not receive awards (“losers”)
might reveal a measurable downturn in
achievement motivation.
• Used as motivation for creative ideas

BENEFITS OF ENDOWMENT EFFECT

 Creates economic value for customers
 Increases feelings of achievement and perceived level of involvement in production
 LABOUR and ENDOWMENT EFFECT – Managers allocate higher resources for projects where they have done more work
(IKEA EFFECT) or projects achieved with difficulty (TROPHY EFFECT)
 Can be used as an Effective Management Tool
CRITICISM AND CONCLUSION
o Some economists have questioned the effect's existence.
o Hanemann (1991) noted that economic theory only suggests that WTP and WTA should
be equal for goods which are close substitutes, so observed differences in these measures
for goods such as environmental resources and personal health can be explained without
reference to an endowment effect.
o Shogren, et al. (1994) noted that the experimental technique used by Kahneman, Knetsch
and Thaler (1990) to demonstrate the endowment effect created a situation of artificial
scarcity.
o They performed a more robust experiment with the same goods used by Kahneman,
Knetsch and Thaler (chocolate bars and mugs) and found little evidence of the
endowment effect.
o Others have argued that the use of hypothetical questions and experiments involving
small amounts of money tells us little about actual behaviour with some research
supporting these points.
REFERENCES

• Knez, Peter; Smith, Vernon L.; Williams, Arlington W. (1985). "Individual Rationality, Market Rationality,
and Value Estimation". American Economic Review. 75 (2): 397–402.
• Shogren, Jason F.; Shin, Seung Y.; Hayes, Dermot J.; Kliebenstein, James B. (1994). "Resolving Differences
in Willingness to Pay and Willingness to Accept". American Economic Review. 84 (1): 255–270.
• Kahneman, Daniel; Knetsch, Jack L.; Thaler, Richard H. (1990). “Experimental Tests of the Endowment
Effect and the Coase Theorem”. Journal of Political Economy. 98 (6): 1325-1348.
• Bühren, Christoph; Pleßner, Marco. (2014). “The Trophy Effect:” Journal of Behavioral Decision Making.
27 (4): 363-377.
VIDEO SUGGESTIONS

• 1. https://www.youtube.com/watch?v=P3Q30wNnL_0
• 2. https://www.youtube.com/watch?v=W5DnFubY2ME