The endowment effect is the phenomenon perhaps most often cited as evidence for loss aversion in the context of riskless choice (Kahneman et al., 1990; Thaler, 1980; Tversky & Kahneman, 1991). The endowment effect refers to the finding that owners of an object demand more to part with the object than nonowners are willing to pay to obtain it (Thaler, 1980). For example, in a classic study, Kahneman et al. (1990) found that individuals endowed with a mug demanded, on average, about $7 to part with it. In contrast, individuals not endowed with a mug were, on average, willing to pay only about $3 to obtain the same mug. The finding that individuals’ willingness to accept (WTA) is greater than their willingness to pay (WTP) appears robust across many different instantiations of the endowment paradigm (Kahneman et al., 1991). It is this central finding that is viewed as evidence for the general principle that losses exert a greater impact than gains.
Although taken as evidence for loss aversion, the endowment effect can be understood as a case of the status quo bias where maintaining the endowed option is the inaction (or status quo) alternative. As such, the endowment effect is subject to the same alternative explanations (e.g., inertia) to loss aversion as those described for the status quo bias. For example, the inertia explanation suggests that when individuals are indifferent between the endowed option and the nonendowed option, they will opt to maintain the endowed option due to lack of incentive to trade, not because the loss of the endowed option looms larger than the gain of the nonendowed option.
Another explanation of the endowment effect, which similarly does not require loss aversion, comes from Weaver and Frederick (2012) and Isoni (2011) (see also Simonson & Drolet, 2004; Yechiam, Ashby, & Pachur, 2017). These authors provide a differential reference price account. They argue that buyers and sellers face fundamentally different decisions that lead them to focus on different reference prices when setting WTP and WTA amounts, respectively. For buyers, their own personal utility from the acquisition of the object is the most salient reference. In contrast, for sellers, the market value of the object is the most salient reference. As a consequence, if market prices tend to exceed personal valuations, owners will ask more for a product than a prospective buyer is willing to pay. For example, if both owners and nonowners value an object at $3, but the market price is $7, owners will demand $7 to part with it, whereas nonowners will only be willing to pay $3 to acquire it. This account, as with inertia, requires no differential sensitivity to losses to explain the endowment effect.
Other potential confounds exist in the endowment effect paradigm. For example, WTP and WTA are assessed on different scales. WTP is bounded by one’s ability to pay (i.e., budget constraints), whereas WTA is not.
In the possible alternative explanations to loss aversion for the endowment effect discussed so far, the valuation of an option when it is the endowed versus the nonendowed option does not differ. However, research also shows that individuals confronted with the decision of whether to give up an endowed option tend to focus more on positive features and less on negative features of the option than those faced with the decision of whether to acquire the option (Carmon & Ariely, 2000; Nayakankuppam & Mishra, 2005; see also Johnson, Haubl, & Keinan, 2007). This process could result in greater valuation for an option when it is endowed than when it is not endowed and, therefore, could be interpreted as a process that leads losses to loom larger gains in the context of the endowment effect. However, two caveats are in order. First, because loss and gain are confounded with inaction and action in the endowment paradigm, rather than reflect a tendency to elevate the option that might be lost, this process could just as well reflect a tendency to elevate the inaction alternative. Second, even if one accepts the idea that a tendency exists to elevate options that might be lost in the context of the endowment effect, it would not imply acceptance of loss aversion itself; that is, the acceptance of a general principle whereby losses loom larger than gains. In particular, to accept a general principle of loss aversion would, at the least, require evidence that losses loom larger than gains across different contexts, including in contexts where losses and gains are not confounded with inaction and action.
The endowment effect and loss aversion