Exchange Asymmetries Incorrectly Interpreted as Evidence of Endowment Effect Theory and Prospect Theory?

Abstract

Jack L. Knetsch (1989) reported an important discovery. Using a simple experiment, he demonstrated the existence of asymmetries in exchange behavior. More precisely, when he followed a specific set of procedures to endow subjects with mugs and provided each subject an opportunity to exchange the endowed mug for a candy bar, he found that very few subjects gave up the endowed mug. By contrast, when he endowed a different group of subjects with candy bars using the same set of procedures, very few gave up the candy bar in exchange for a mug. While Knetsch, and many of those who followed him, interpreted the asymmetry as evidence of a special shape of preferences related to loss aversion (Knetsch 1989(Knetsch , 1277), our results demonstrate that observed asymmetries should be attributed instead to well-established alternative economic theories that influence choices through the experimental procedures employed.Knetsch's initial intuitions have been expanded in a large and growing literature claiming that observed exchange asymmetries support "endowment effect theory"-an application of prospect theory positing that loss aversion associated with an endowment leads to asymmetries in valuations and exchange behavior. We use the term "endowment effect theory" rather than "endowment effect" to avoid the confusion over terminology that has emerged in the literature. From the beginning (i.e., Richard H. Thaler 1980), the label "endowment effect" has been used commonly to refer to observed symmetries. Using this label to refer to the observed phenomenon is problematic because it suggests a particular Exchange Asymmetries Incorrectly Interpreted as Evidence of Endowment Effect Theory and Prospect Theory?By Charles R. Plott and Kathryn Zeiler* theory as an explanation for asymmetries. To say that an observed phenomenon demonstrates an "endowment effect" does not simply denote that an asymmetry was observed; rather, use of the label implies that a very special form of preferences causes the asymmetry. We use "endowment effect theory" to distinguish the theoretical explanation from the observed phenomenon, which we refer to in this narrow context as an "exchange asymmetry." Specifically, endowment effect theory posits that individuals perceive parting with an endowed good as a loss that is greater than a potential gain from acquiring another good of otherwise equal value (Thaler 1980, 44). In turn, this interpretation generates support for a specific theory of choice behavior called prospect theory, of which loss aversion is a major component.

A Canonical Model of Choice with Initial Endowments

“…Now, the vast majority of students kept their endowments (around 90 percent versus initial 50 percent). (For a critical experimental evaluation, see Plott and Zeiler (2007).) There is also plenty of (indirect) field evidence that support the (weak) status quo bias hypothesis.…”

Behavioral foundations of environmental economics and valuation

“…Hence experienced traders in the List model would not expect to retain the sports card with which they were endowed. Likewise in the Plott and Zeiler (2007) experiments, the experimental procedures effectively separated the endowment from the reference point with careful instructions. Consistency in this context means that an individual who weakly prefers A to B must not strictly prefer B to A.…”

Reconsidering the Effect of Market Experience on the ''Endowment Effect''

“…But little is known about how market experience succeeds in teaching participants to avoid 1 We agree with Plott and Zeiler (2007) that the term "endowment effect" is problematic, as it already entails an interpretation of the phenomenon observed, namely that too little trade in simple exchange experiments is driven by the fact that players are endowed with one of the goods and experience loss aversion with respect to their endowment. We follow Plott and Zeiler in using the term "exchange asymmetry".…”

“…This only addresses uncertainty about which of the consumption bundles is preferred, but does not include phenomena such as loss aversion. by, e.g., Plott and Zeiler (2007) and Braga and Starmer (2005), who distinguish between "institutional learning" and "value learning". This distinction parallels to a certain extent our own between trade and choice uncertainty, but Braga and Starmer's institutional learning is more related to subjects' understanding of the technical functioning of the mechanism (similar to Plott and Zeiler, 2005), whereas trade uncertainty captures the (social) risk associated with the mechanism.…”

“…Plott and Zeiler (2007) have demonstrated that exchange asymmetries can be influenced by experimental procedures. In order to control for any aspects that might influence the results, we applied exactly the same procedure in each session.…”