Events at CERGE-EI

Prof. Lorenz Goette

Université de Lausanne, Switzerland

Authors: Lorenz Goette, Annette Harms, and Charles Sprenger

Abstract: The endowment effect is a reliable feature of human behavior: individuals value a good more when it is in their possession than when they are given the opportunity to buy that same good (Kahneman, Knetsch and Thaler, 1990). It cannot be explained by the standard model, but can be rationalized by reference-dependent preferences that display loss aversion (Kahneman and Tversky 1979; 1991). Key to understanding the disparity between buying and selling prices is to understand where the different reference points for buyers and sellers come from.

In this paper, we test the Koszegi-Rabin (2006) model that proposes that the reference point is formed in expectations. We conduct a standard endowment effect experiment. However, we introduce a new element: with probability p, we force sellers to exchange their mug at the market price even if they did not want to, and buyers to buy the mug even if they chose not to. If reference points are driven by expectations, the possibility of a forced exchange prevents sellers from expecting to keep the mug, and should thus lower their selling price. However, introducing a probability of forced exchange does nothing to the endowment effect. The endowment effect remains stable across all conditions. We overwhelmingly reject each of the predictions by the Koszegi-Rabin model, and any model that places expectations at the center of reference points. Our results provide strong evidence against the hypothesis that reference points are shaped by expectations.

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