An investigation of the endowment effect in the context of a college housing lottery - Nash & Rosenthal (2014) - Article

What is the endowment effect?

The endowment effect refers to the finding that people expect more compensation to give up a product or a service that they own, than they would be willing to pay to acquire the same product or service if they did not own it. Some factors can be identified that contribute to the endowment effect, namely high involvement goods, high quality good, and attractive goods. To visualize the endowment effect a distinction is made between the selling-price and the buying-price. The selling-price is the price that the person who owns the good would want to be willing to sell it. The buying-price is the price that the person who does not own the good is willing to pay in order to acquire it.

What problems does previous research have when investigating the endowment effect?

Previous studies have problems with the ecological validity. Some of the studies used goods that were not particularly meaningful to the participants. Other studies used within-participant designs, meaning that participants were both buyer and seller. These issues are addressed by using a between-participant design and by using a meaningful good (student housing). The current study looks at whether there is an endowment effect immediately after housing selection (comparing students who were given their first choice with students who were denied their first choice), and what the effect is of experience and knowledge on the endowment effect. 

What is the effect of ownership on the endowment effect?

Previous research indicates that experience enhances the endowment effect. The valuation of goods increased with the duration of the ownership. The endowment effect was mediated by participants´ feelings of ownership. The feelings of ownership were enhanced by physical possession of the good. With regards to the current experiment and student housing, the expectation is that experiencing the first choice for a while will increase the value that the sellers place on the good and that the price will rise compared to the price that they initially wanted. With regards to the buyers, it is expected that if they have a negative experience in their second-choice student housing, they will be willing to pay more for the first-choice housing, whereas if they have a positive experience in their second-choice housing, they will reduce the price they are willing to pay for the first-choice housing.

What are the main conclusions in the research of Nash and Rosenthal?

The results show a significant endowment effect at both times (right after the housing lottery, and again after two months of living in the assigned housing). The selling-price exceeded the buying-price at both times. Also, the selling-price increased over time, whereas the buying-price did not change. This can be explained by loss aversion and how it induces a reluctance to sell something (especially after having owned the good). The experience of owning the good and the familiarity it creates, impacts the aversion to loss. It creates a tendency to increase its value over the initial valuation. Contributing to the variability of possession attachment in individuals are individual attachment styles.

In what way does the type of good/service cause differences in the endowment effect?

Some goods, like the student housing, do not have a real market and a real value. When students are then asked to assign value with no limitation, they tend to overstate their selling-price and understate the buying-price, increasing the disparity. The endowment effect should thus be bigger for non-market goods. On the other hand, when the product being sold/bought has many affordable substitutes, the values of the selling-price and the buying-price are closer to each other. A final distinction can be made between hedonic goods and utilitarian goods. Hedonic goods are those whose consumption is focused on gratification. Utilitarian goods are those with a consumption focused on function. The endowment effect appears to be greater when it concerns hedonic goods.