Collard, Walford, Vernon, Itagaki, and Turk (2020) on Endowment, Ownership, and Culture

Philip Collard, Alexandra Walford, Lucy Vernon, Fumihiko Itagaki, and David Turk, “The Relationship Between Endowment and Ownership Effects in Memory Across Cultures.” Consciousness and Cognition 78, February 2020, 102865. 

• One manifestation of endowment effects is that people require more money to part with an owned item (willingness-to-accept, WTA) than they are willing to pay (WTP) to acquire such an item if it is not yet owned – as if the mere fact that you own something raises its value to you. 

• Prospect theory offers one explanation for endowment effects: things you own become part of your reference point, so to “lose” them is particularly painful, thanks to loss aversion. 

• But maybe the endowment effect is not about loss aversion, perhaps it is about your identity being connected to owned items. You have a positive view of your self-worth, so things that become associated with your self become more valuable in your eyes. Ownership of items also has been connected with an increased ability to remember the item down the road. 

• Hmm, but maybe in some cultures people are not so wrapped in self-worth that they raise the value of stuff they own because it is connected to them? Maybe cultures differ, too, in how much ownership of an item increases the ability to recall the item? 

• Experiment 1 (n=32): eight household goods are divided into two equally-valued sets of 4 items each, where those equal values are based upon student valuations collected in a pre-experiment. A participant is told that they own one of the sets but not the other. Then each of the eight items is shown, and the subject indicates how much they would be willing to sell the item for (if they “own” it) and how much they would be willing to pay for it (if they don’t own it). 

• The 32 British undergraduates showed an endowment effect: they were willing to pay on average 9.25 pounds for the unowned set, but would have to be paid 10.65 pounds to part with their “owned” items. But would a similar endowment effect be identified if the experimental subjects were not British but Japanese? 

• For Experiment 2, 61 British undergraduates were recruited, along with 52 Japanese undergraduates. A version of Experiment 1's endowment task was performed, along with new ownership and memory tasks. In the endowment experiment, the Japanese students showed no endowment effects, but once again, the British did. (The endowment task was not identical in the UK and Japan for an unexpected reason: one of the everyday items that made up part of the sets of goods was not available in Japan! "For the Japanese participants, the spatula was replaced with a ladle as the former item was not available locally [p. 4].") 

• As for remembering the items, the British subjects were much better for the items they “owned” than for ones they did not own, but the Japanese showed no difference in recall based upon ownership. Further, British subjects (but not the Japanese) showed a positive correlation between their endowment effects and the impact of ownership on their recall. 

 • Maybe these (British) endowment effects are not about loss aversion, but rather about connections to self?

Smitizsky, Liu, and Gneezy (2021) on Endowment Effects

Gal Smitizsky, Wendy Liu, and Uri Gneezy, “The Endowment Effect: Loss Aversion or a Buy-Sell Discrepancy?.” Journal of Experimental Psychology: General 150(9): 1890–1900, 2021; https://doi.org/10.1037/xge0000880. 

• The endowment effect, loosely: you value stuff more when you own it than when you don’t. 

• A standard way to “identify” endowment effects is to document a notable difference between the amount someone is willing-to-pay (WTP) to acquire an item and the amount that, if they already have the item, they would need to be paid to relinquish it (willingness-to-accept, WTA). 

• A WTA that is substantially higher than the WTP is evidence for an endowment effect. 

• A prospect theory-style explanation for endowment effects invokes loss aversion. Your reference point changes to include stuff you own, so to depart with owned stuff is coded in the loss domain. 

• An alternative explanation for WTA/WTP gaps is that people bring their buying and selling selves into the lab with them. Strategically, in the real world it often makes sense for buyers to understate their WTP and sellers to overstate their WTA, and maybe those strategies survive in the lab, despite efforts to incentivize truthful responses. 

• The authors invent the “Pay to Keep” condition. [Though for a parallel, see the “retention paradigm” of Gal and Rucker (2018).] There is no selling, only keeping, in this condition. If the amount you are willing-to-pay to keep (PTK) is similar to WTP (and hence typically less than WTA), the “endowment effect” can’t be due to loss aversion: unlike with WTP, the PTK condition involves a loss of something “owned,” but PTK is still below WTA. Any discrepancies (between PTK and WTA, and between WTP and WTA), then, might be consistent with subjects adopting buyer/seller roles. 

• In testing the role of Pay to Keep, those who are offered the opportunity to pay to keep their item must believe that they already “own” the item, that it is part of their endowment. 

• So, the experiments involve three conditions: WTP, WTA, and PTK. Subjects find a nice college-branded pen at their station when they enter the lab. 

• In the WTA and PTK conditions, subjects are told that the pen is theirs, and they should use it to complete some boring task. In the WTP condition, the pen is just near the subject and they are told “no touchies;” they complete the boring task with a pencil instead. 

• After the boring task, WTP folks are asked, want to buy the cool pen (and how much will you pay)? 

• WTA folks are told they could sell their pen (how much would they need to be paid?) or just take it home. 

• PTK folks are told, sadly, pay for the pen or lose it. How much are you willing to pony up? 

• In the experiments, WTP and PTK are similar on average, and much less than WTA. 

• So, there’s an endowment effect (WTA-WTP gap as well as WTA-PTK gap) – but no evidence for loss aversion, as the PTK folks think (?) that the pen is theirs, part of their endowment, even though they have to pay to keep it. 

 • People are not more interested in keeping the pen than in buying the pen: the valuation gaps can be due to buyer/seller discrepancies, though not to loss aversion.

O’Donoghue and Somerville (2018) on Risk Aversion

Ted O’Donoghue and Jason Somerville, “Modeling Risk Aversion in Economics.” Journal of Economic Perspectives 32(2): 91-114, Spring, 2018.

• As Rabin and Thaler (2001) indicate, expected utility (EU) maximization seems incapable of explaining people’s risk preferences – even though it does suggest some nice measures of the degree of risk aversion. 

• Other models of risk aversion, however, might prove more empirically sound, while maintaining tractability. That is, we might not need expected utility to analyze problems involving risk aversion, as alternative models could replicate current standard, EU-based results, while offering still more or avoiding the shortcomings associated with the assumption of EU maximization. 

• Consider standard findings associated with insurance: (1) A more risk averse person is willing to pay more for insurance (than is a less risk averse person); and (2) at a fixed price per dollar of insurance (fixed in excess of the actuarially fair price), a more risk averse person will purchase more insurance (than will a less risk averse person). 

• Consider standard findings associated with financial investments: (1) In a world with one safe (riskless) and one risky asset, more risk averse people invest less in the risky asset; and (2) if the population as a whole becomes more risk averse, the price of the risky asset must fall (equivalently, the expected return from holding the risky asset must rise). 

• Consider standard findings of principal/agent analysis, say, when a risk neutral principal hires a risk averse agent: (1) if the agent’s effort is not observable, then to encourage effort, the agent will have to bear some risk (so that lower output leads to less pay); and (2) the unobservability of effort is costly to the principal, who would prefer to contract on effort directly. 

• The various claims made concerning risk aversion in the three previous bullet points do require risk aversion – but they do not require expected utility maximization. That is, many of the ideas that have been developed around the concept of risk aversion – developed in the context of expected utility maximization – remain valid even when expected utility maximization is not descriptively accurate.

• Consider loss aversion as an alternative approach, one where outcomes are judged against a reference point and “losses loom larger than gains.” For prospects with some loss and some gain outcomes, loss aversion can generate risk averse behavior. (This style of loss aversion does not require "diminished sensitivity," the feature of prospect theory that leads to risk averse behavior in the gains domain and risk seeking behavior in the losses domain.)

• A second alternative, also featured in prospect theory, is probability weighting. The general notion is that, in practice, decision weights might not equal objective probabilities. Specifically, probability weighting typically involves the overweighting of low probability events and the underweighting of high probability events. This type of probability weighting can generate, depending on the options, either risk seeking or risk averse behavior. Lotteries, for instance, might be attractive (induce risk seeking behavior) due to the overweighting of the low-probability outcome of a large win. 

• Finally, consider contextual features and salience. Extreme or vivid outcomes (like deaths in terrorist attacks) might garner intense attention, leading to higher decision weights on those outcomes. The contextual feature of the available (although unchosen) options can exert influence by shifting the salience of other outcomes. Again, choices displaying risk aversion can arise from these factors. Expected utility maximization is neither necessary nor sufficient for explaining risk-averse behavior.

Simonson and Kivetz (2018) on Gal and Rucker (2018) on Loss Aversion

Itamar Simonson and Ran Kivetz, "Bringing (Contingent) Loss Aversion Down to Earth — A Comment on Gal & Rucker’s Rejection of 'Losses Loom Larger Than Gains,'" Journal of Consumer Psychology 28(3): 517-522, July 2018.

• The articles outlined in the two previous posts are part of a "Research Dialogue"; Simonson and Kivetz's reply to Gal and Rucker, outlined here, is an element of the same dialogue.

• Gal and Rucker are right in that loss aversion is neither as firmly established nor as universal as is typically thought. Nonetheless, their retention paradigm is not convincing evidence of an endowment effect sans loss aversion, and they underplay some of the strongest evidence in favor of loss aversion: people demonstrate significant aversion to a risky but highly favorable (in expected value terms) bet, when opposed to a riskless gain (or the status quo) that offers much less in expected value. People routinely turn down 50-50 bets that pay $200 if heads and lose $100 if tails. 

• “[T]he question relevant at the present time for our field is not whether loss aversion occurs on average (we think it does), but what factors moderate its presence and magnitude, and relatedly, what are its boundaries [page 518]?” 

• Much of the evidence for the endowment effect (like the unwillingness to trade mugs for candy bars or vice versa) is consistent with plausible, non-loss-aversion explanations, such as the awkwardness in coming to an agreement for trivial trades. But the retention paradigm is not very convincing as new evidence against loss aversion, because of the highly artificial settings that arise in trying to reframe the retention of something you own as an active choice. 

• In many circumstances, loss aversion does seem to be part of what is going on with endowment effects, even if other mechanisms, such as transaction costs, also are at play. Losses do tend to loom larger than gains, but this is a tendency, one contingent on other factors, and not a universal truth. 

• As Gal and Rucker (2018) note, the excessive commitment to loss aversion might crowd out research that can identify other factors that drive decision making.

Higgins and Liberman (2018) Reply to Gal and Rucker (2018) on Loss Aversion

E. Tory Higgins and Nira Liberman, "The Loss of Loss Aversion: Paying Attention to Reference Points," Journal of Consumer Psychology 28(3): 523-532, July 2018.

• The Gal and Rucker loss aversion article outlined in the previous post was part of a "Research Dialogue"; Higgins and Liberman's reply, outlined here, is an element of the same dialogue.

• Higgins and Lieberman agree with Gal and Rucker: the empirical support for loss aversion is not as strong as its reputation would suggest. Loss aversion is not universal. The more general (than loss aversion) notion of prospect theory – that “reference points increase people’s sensitivity to objective changes in value [p. 523]” – is still viable, however.

• Losses and gains in prospect theory are judged relative to some reference point, which often is taken to be the status quo. If the reference point is not the status quo, however, then gains (relative to the status quo) need not be less powerful than losses, even if that loss-aversion-style result would be case were the status quo the relevant reference point. Further, multiple reference points can be at play at any one time.

• Reference points tend to be outcomes which attract our attention. As a result, we are more sensitive to changes around those points than from changes elsewhere. But this increased sensitivity need not be asymmetric, need not involve loss aversion: sensitivity to either gains or losses or both can increase around references points.

• A second suggestion is that a relevant reference point when judging an outcome is what might have happened instead, the chief counterfactual; gains or losses relative to that alternative will take on intensified value. To just make a train is more enjoyable than making it easily, and to just miss it is more painful than to be much too late. Again, this approach does not suggest the sort of asymmetry that loss aversion requires.

• Reference points such as goals – 10,000 steps per day – might suggest loss aversion: step 10,000 is worth a lot more than step 10,001 – but, Higgins and Lieberman argue, goals as reference points need not involve loss aversion. Many market-based goals have built-in incentives that are more sensitive above the goal – for instance, an increased percentage of royalties from book sales – than below the goal.

• In long-term pursuits, dual reference points can be at play: the starting position might be most salient early in the process, but the ultimate goal takes on more prominence as the pursuit unfolds. Recall that Gal and Rucker suggest that what is taken to be evidence of loss aversion in the literature often can be explained by an inaction bias, where no loss aversion is at play. For long-term pursuits, the “action” alternative is the one for which this dual reference point view seems most apt, and the additional reference point (the goal) can be the source of a greater sensitivity in valuation from changes in the action alternative than in the inaction alternative. 

• Some people (the “promotion-focused”) might concentrate on progress, and others (the “prevention-focused”) might concentrate on avoiding losses. Even if the status quo is the same for both individuals, they compare it with different alternative reference points. For the promotion-focused, the status quo is a loss relative to the desired progress; for the prevention-focused, the status quo is a gain relative to the feared worsening. 

• If a prevention-focused person found herself below the status quo, she might choose risky strategies if they are her only hope of restoring the status quo. Promotion-focused people, alternatively, starting from below the status quo, will not feel all that motivated to regain the status quo (both are losses, given the reference points at work), but will be more motivated to go from the status quo to a better point. This story, for which there is empirical support, is not consistent with standard prospect-theory-style loss aversion. That is, Gal and Rucker are right, in that the psychological evaluation of negative events (losses) are not always greater than the evaluation of equivalent gains, and people are not always more motivated by the threat of losses than by the prospect of gains. 

Gal and Rucker (2018) on the Loss of Loss Aversion

David Gal and Derek D. Rucker, “The Loss of Loss Aversion: Will It Loom Larger Than Its Gain?” Journal of Consumer Psychology 28(3): 497-516, July 2018.

• Social scientists seem to all but universally believe in loss aversion, the notion that losses “loom larger” psychologically than do similarly-sized gains.

• Gal and Rucker claim that the actual evidence does not support any general tendency for losses to loom larger than gains: everything depends upon the context.

• There’s a bit of circularity in the promotion of loss aversion: some phenomenon (like the equity premium puzzle or the endowment effect) is “explained” by loss aversion, and then the existence of the phenomenon (the equity premium, the endowment effect) is taken to be evidence that loss aversion is pervasive. 

• The status quo bias might reflect a preference towards inaction – and such a preference can exist in the absence of loss aversion, due to the lack of a motive for action, or economizing on processing costs, or the tendency to regret errors of commission more than errors of omission. 

• When asked to trade their original good for an essentially identical one, loss aversion is not implicated – but people still show a large status quo bias. Action v. inaction confounds the loss-gain story. 

• Is the endowment effect just a case of a status quo bias, and therefore does not require loss aversion? 

• The “retention paradigm” recasts endowment effect experiments as willingness-to-pay (WTP) to obtain an item v. WTP to retain an item – so now the “inaction” choice is not to have the good in both cases. (That is, the confounding of loss aversion with inaction is sidestepped.) 

• If loss aversion is active, then in the retention paradigm, the WTP to retain will be higher than the WTP to obtain. But in the experiments, there was no premium to retain a good or service. For “mundane” goods – mugs, notebooks – obtaining tended to have a higher WTP than retaining. 

• One has to be creative to come up with reasonable “retain” scenarios! Fixing a broken phone, perhaps? 

• Analogous experiments ask if you would like to receive $0 for a good you own, or exchange it for another good. The second condition swaps the owned and alternative good. Mug v. $5 shows no endowment effect – even though the standard exchange paradigm (that is, not the "retention" paradigm) with these goods shows a significant endowment effect. 

• For the standard “loss aversion ratio” test, not accepting the bet is the status quo. This test, too, can be recast: Would you rather receive $0 with a probability of 1 or take a 50-50 bet with the possibility of winning or losing $15? People seem to have a slight preference for the risky alternative. 

• When stakes are higher, preferences shift toward the sure thing – but this could reflect risk aversion, not loss aversion. (And, loss aversion is generally taken to be independent of the stakes.) 

• When you ask people directly about the psychological impact of winning or losing something – you ask them how they feel about these events – losing doesn't dominate in terms of the magnitude of feelings. How do you feel about losing a mug versus winning a mug? 

• How do you feel about losing $3 versus winning $3? What about $100? At the low stakes, people seem to care more about the gain. 

• Loss “frames” are not generally more motivating than “gain” frames (despite some evidence to the contrary in certain domains). 

• Why is loss aversion so popular given its questionable evidentiary base? Perhaps in part due to a status-quo bias among researchers(!), or confirmation bias within Kuhnian “normal science.” 

• Loss aversion holds intuitive appeal: we all feel some losses acutely. And the name “loss aversion” itself is persuasive.

Vis and Kuijpers (2018) on Prospect Theory and Foreign Policy

Barbara Vis and Dieuwertje Kuijpers, “Prospect Theory and Foreign Policy Decision-Making: Underexposed Issues, Advancements, and Ways Forward.” Contemporary Security Policy 39(4): 575-589, 2018.

• Risk, in both prospect theory and in useful foreign policy applications, involves outcome uncertainty—so risk considerations are important in the gains domain as well as the loss domain. 

• Probability weighting often is ignored in applications of prospect theory, but it can override the usual “risk averse for gains, risk loving for losses” result. 

• In particular, low probability gains might see risk loving behavior, and low probability losses might be met with risk averse behavior. 

• And in foreign policy applications, low probabilities for unusual events are common. 

• Multiple dimensions are relevant in foreign policy decisions, so there can be multiple reference points, and outcomes might involve gains with respect to some reference points but losses with respect to other reference points. 

• When (to whom and for what decisions) might prospect theory apply? What decisions are better described by expected utility theory? 

• Oddly, ambiguity goes unmentioned in this article.

Rouyard et al. (2018) on Prospect Theory and Chronic Disease

Thomas Rouyard, Arthur Attema, Richard Baskerville, José Leal, Alastair Gray, “Risk Attitudes of People with ‘Manageable’ Chronic Disease: An Analysis Under Prospect Theory.” Social Science & Medicine 214: 144-153, 2018.

• Many patients are non-compliant with recommended medical treatments, at a cost to their health. Is it possible that their choices reflect risk-loving behavior in the loss domain?

• Two outcomes are examined in this study, longevity and quality of life. The usable sample size is n=110; 52 members of this sample have Type 2 diabetes mellitus.

• The empirical approach is aimed at identifying the prospect theory “value function” (in both the loss and gain domains) and the probability weighting (of an objective probability of .5). The estimation of the value function includes an estimation of the extent of loss aversion.

• Many questions are of the nature: Your status quo is to live 20 more years with an excellent quality of life. You must choose between option A, which would give you (with certainty) an additional 3 years of life with a pretty good quality of life, or option B, which offers a 50% chance of gaining 6 years of life, 3 years of high quality and 3 years of low quality, and a 50% chance of remaining with the status quo.

• For loss aversion, the relevant question is of the nature: The status quo is to live 20 more years with an excellent quality of life. A risky prospect available to you involves a 50% probability of gaining an additional 10 years of life with a pretty good quality of life, and a 50% probability of losing L years of life. What is the L that makes you indifferent between the risky prospect and the status quo?

• The authors find that most folks are risk averse in both the loss and gains domains. Older people tend to be more risk averse. Loss aversion is significant (median λ=1.19).

• It probably isn’t risk seeking that leads to medical noncompliance.

Shrader, Wooten, White, et al. (2017) on Using Loss Aversion to Motivate Students

Rebekah Shrader, Jadrian James Wooten, Dustin R. White, et al., “Improving Student Performance through Loss Aversion.” December 12, 2017; updated version available here.

• Pairs of nearly identical courses are offered, where one element of each pair calculates student points as losses from a perfect base: a score of 50 means the student has lost 50 points, as opposed to the usual (control) case where points accumulate with correct assignments. 

• The idea is to see if the “loss framing” triggers greater student effort in a bid to avoid or minimize losses (as opposed to hoping to acquire gains); that is, the authors are testing to see if enlisting aversion towards losses via the grading framework leads to better student performance. 

• Students were not informed when they signed up for their classes that they were part of a field experiment. 

• The loss framing (“counting down”) was associated with higher grades – some 2.6 to 4.2 percentage points higher. 

• Did students perform better in the loss framework simply because it was unusual? 

• A couple of related papers. not (yet?) covered by Behavioral Economics Outlines, are Roland G. Fryer, Jr, Steven D. Levitt, John List, and Sally Sadoff, “Enhancing the Efficacy of Teacher Incentives Through Framing: A Field Experiment," April 2018, pdf here) and Steven D. Levitt, John A. List, Susanne Neckermann, and Sally Sadoff, “The Behavioralist Goes to School: Leveraging Behavioral Economics to Improve Educational Performance,” American Economic Journal: Economic Policy 8(4): 183-219, November 2016. 

Wang, Rieger, and Hens (2017) on Culture and Loss Aversion

Mei Wang, Marc Oliver Rieger, and Thorsten Hens, “The Impact of Culture on Loss Aversion.” Journal of Behavioral Decision Making 30: 270-281, 2017.

• Wang, Rieger, and Hens look at loss aversion in 53 countries. The underlying notion is that emotions are implicated in loss aversion, but the display and regulation of emotions is culturally influenced.

• In their data, higher (nationwide) levels of loss aversion are connected to: individualism; “power distance” (which means strength of social hierarchy, according to Wikipedia); and masculinity. A fourth factor, uncertainty avoidance, is less meaningful. These factors are drawn from a 2001 book on the consequences of culture by Geert Hofstede. [But it seems the subsequently expanded Hofstede criteria might be even more connected to loss aversion. Again, from Wikipedia: “Independent research in Hong Kong led Hofstede to add a fifth dimension, long-term orientation, to cover aspects of values not discussed in the original paradigm. In 2010, Hofstede added a sixth dimension, indulgence versus self-restraint.”] 

• Loss aversion is measured by the answers to two questions. If you have a 50% chance of losing $25, and a 50% chance of winning x, how high does x have to be for you to agree to take this bet? The second question replaces $25 with $100. The loss aversion parameter is determined by dividing the answer by the stakes (25 or 100), and the overall measure averages the two stake-differentiated results. 

• The survey is given to college students and the stakes are expressed in ways that, for students, are comparable across countries. Georgians have (easily) the highest loss aversion, at 7.5, with a few countries (Luxembourg, Bosnia, Tanzania) around 1 (no loss aversion). The mean across countries is 2.0. Eastern Europeans have the highest loss aversion, and Africans have the lowest. 

• Women tend to be more loss averse, even though an increase in “masculinity” brings higher loss aversion. A greater percentage of Orthodox Christians leads to more loss aversion in a nation. 

• Economic factors don’t seem to matter: it is culture, not the economy, that drives international differences in loss aversion.

Larson, List, and Metcalfe (2016) on Myopic Loss Aversion and the Equity Premium Puzzle

Francis Larson, John A. List, and Robert D. Metcalfe, “Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders.” August 31, 2016; available here.

• The puzzle: the real return on US equities is about 8% per annum, versus about 1% for riskless assets. This spread cannot easily be explained as a risk premium. 

• One hypothesis: traders display myopic loss aversion (MLA), and hence the frequent downticks (short-term declines in asset value) are psychologically costly – people will only put up with these costs if there is an offsetting premium in the monetary return. If MLA can explain the equity premium puzzle, then it must be present in the “marginal” trader. 

• Laboratory experiments have found that myopic loss aversion is common. The standard design involves varying the rate at which price information is delivered to traders. Those who receive information at high frequency are exposed to more revelations of downticks, and hence, if they display MLA, they will underinvest in the risky asset, the one that is subject to lots of downticks. 

• The Larson, List, and Metcalfe paper employs a (natural?) field experiment, where traders do not know they are taking part in an experiment; they think they are beta-testing a new online trading platform. 

• The traders' recompense is to be paid eventually in-kind based on the profits that they accrue during their two weeks of testing. They can “buy” a risky asset whose return is tied (in a not-fully-obvious way) to the US dollar exchange rate. The tying is such as to bias the return to the asset to be positive. 

• The experiment reveals MLA – traders who are given infrequent (once per 4 hours) price updates keep more of their stake in the risky asset, and earn considerably more, than those traders who receive second-by-second updates. 

• Traders tend to desire more frequent price updates, but perhaps that information degrades their performance. 

• Since both the Frequent (n=73) and Infrequent (n=78) groups of traders can trade at any time, this experiment avoids a confounding feature of past laboratory experiments, that both information and trade opportunities are altered among conditions.

Bartling, Brandes, and Schunk (2015) on Soccer and Reference Points

Björn Bartling, Leif Brandes, Daniel Schunk, “Expectations as Reference Points: Field Evidence from Professional Soccer.” Management Science 61(11): 2646-2661, 2015; working paper version (pdf) here.

• Do soccer teams play differently, and less “rationally,” when they are in the loss domain relative to expectations?

• Betting odds give a measure of expectations for match outcomes in professional soccer; so, we can test if teams play differently, and less rationally, when they are in the loss domain (performing worse than expected).

• Indicators are the numbers of yellow cards and red cards, as well as substitution patterns.

• The rationality of any changed behaviors in the loss domain can be checked by how final outcomes are influenced.

•If a team that is favored is behind, they are in the loss domain. These teams receive more cards (by 14%), and their coaches make more offensively-minded substitutions (by a large margin), than if the game situation were the same but the team was not in the loss domain. 

• Both the additional cards and the increase in offensive substitutions seem to lead to worse outcomes for teams. 

• The additional cards when a team is in the loss domain tend to be related to frustration-style events, such as dissent or violent conduct. The loss domain is psychologically more challenging and this leads to worsened decision making.

• For more on reference points and soccer, see the BEO post on the Dickson, Jennings, and Koop (2016) analysis of Domestic Violence and Glaswegian Football. 

Professor Thaler’s American Economic Association Presidential Address

Richard H. Thaler, “Behavioral Economics: Past, Present, and Future.” American Economic Review 106(7): 1577–1600, 2016 (working paper pdf available here).

• Economics provides an approach to optimal decision making -- and that is well and good. But we should not let that model distract us from how people actually make decisions.

• When people make decisions, they make them as fallible Humans, not as textbook Econs. They remain fallible Humans irrespective of how often we are told that: (1) their decisions will look "as if" they are Econs; (2) their departures from the full Econ will be unsystematic; (3) when the stakes are high they will convert into Econs; (4) with time they will learn to be Econ; and, (5) the special magic of market settings will see to it that only Econs survive.

• Does the market "get prices right"? Consider the closed-end mutual fund with ticket symbol CUBA. Typically, CUBA is priced at about a 10-to-15 percent discount relative to its underlying assets. But after December 18, 2014, CUBA started to trade at a 70% premium over the value of its underlying securities, and premium pricing continued for about a year.

• Why? On December 18, 2014, President Obama announced that the US would normalize diplomatic relations with Cuba. The CUBA mutual fund has nothing to do with the country of Cuba.

• When Humans make decisions under uncertainty, the sort of preferences they display are not those of expected utility theory. Rather, many decisions seem to involve "prospect theory"-style preferences: (1) utility is based on changes in wealth from some reference point; (2) people are loss averse; and (3) people do not weight potential outcomes according to the objective probabilities.

• For intertemporal preferences, people often display a present bias, a taste for instantaneous gratification, and in many ways, do not exhibit exponential discounting.

• As with preferences, people also do not seem to hold fully rational beliefs. In particular, people display excessive optimism and excessive confidence in their beliefs.

• Actual choices are influenced by "supposedly irrelevant factors [p. 1595]," where the supposition of irrelevance is made within standard economic models. For instance, default settings tend to influence ultimate choices, even in high-stakes situations (such as retirement planning) where the defaults are less-than-optimal and easy to override.

• In the future, economic models will incorporate those behavioral features that best improve their predictive accuracy without imposing high costs in terms of complexity; "behavioral" will disappear as an adjective for a subset of economics, as all economics will be as behavioral as necessary.

Morewedge and Giblin (2015) Look to Explain the Endowment Effect

Carey K. Morewedge and Colleen E. Giblin, “Explanations of the Endowment Effect: An Integrative Review.” Trends in Cognitive Sciences 19(6): 339-348, June, 2015 [pdf].

• Endowment effects tend to be demonstrated in one of two ways: (1) the “exchange paradigm,” where people who are endowed with a good are less willing to trade it for another good than pre-endowment preferences would suggest; and, (2) differences between the willingness to pay (wtp) for a good by a non-owner and the willingness to accept payment (wta) by an owner – differences which seem to materialize about the time the non-owner becomes an owner. 

• Loss aversion is a standard underlying explanation for the endowment effect; once you own a good (or even expect to), your ownership becomes your reference point, and situations where you no longer own it are evaluated as losses relative to the reference point. 

• The authors look at five underlying mechanisms that are claimed to give rise to loss aversion and endowment effects, and offer a more general framework: “attribute sampling bias.” 

• Buyers and sellers pay attention to reference prices (low for buyers, high for sellers) that will increase their transactional utility. Prices are just one example of how buying and selling activate different cognitive frames that direct attention and recall to different pieces of information. Buyers and sellers do not have the same information readily in mind, so the endowment effect does not arise because they value identical attributes differently. People even have trouble recalling frame-inconsistent information. 

• Psychological ownership raises wta for two reasons: (1) ownership creates a connection between your identity and the good; the better that you feel about yourself, the better you will feel about the good. Losing the good can seem like a threat to your identity. (2) ownership helps you remember good feelings about the good, which otherwise might be harder to access. 

• Their attribute sampling bias explanation resembles the well-known phenomenon where people seek out information that confirms their current beliefs. 

• Sadness tends to reduce or reverse the endowment effect – it creates an implicit interest in changing your circumstances, so non-owners are more willing to acquire a good and owners are more willing to sell a good. But most frames in the exchange setting (other than sadness) tend to bias people towards maintaining the status quo. 

• People are eager to trade away a “bad”, which can’t be explained by some other approaches to endowment effects, where whatever you own you value more highly. Further, endowment effects are higher for those goods (like environmental goods) that have vague attributes, giving more room for attention to a biased sample of attributes to take effect.

Viscusi and Gayer (2015) on Reasons to Distrust Government Nudges

W. Kip Viscusi and Ted Gayer, “Behavioral Public Choice: The Behavioral Paradox of Government Policy.” Harvard Journal of Law & Public Policy 38(3): 973-1007, 2015 [pdf].

• Behavioral departures from full rationality are often used as justifications for government interventions in markets. But the resulting government policies can institutionalize, not rectify, the rationality shortfalls.

• Regulators themselves possess rationality shortfalls, and there are features of the environment in which regulators operate that push them away from pursuing first-best policies.

• If the median voter possesses biases, then a democratic government is likely to share those biases.

• Less-than-rational individuals tend to bear the costs of their errors themselves – not so with regulators. Further, individuals might have enhanced incentives (relative to bureaucrats) to acquire relevant information. Regulators, like all of us, can be overconfident in their abilities.

• Can we trust the claims that people are less-than-rational, or at least the universality of the claims? People are heterogeneous, and what looks like a mistake might reflect specific, reasonable preferences.

• Many consumer durables now have energy efficiency mandates, justified by internalities. But the energy-efficiency misjudgment is far from a proven problem. The claims of energy savings tend to be engineering-based, unavailable in practice, while individual circumstances can rationalize seemingly myopic choices.

• We could be more confident in an even-handed use of behavioral economics if a lot of pre-existing mandates were being replaced by non-coercive nudges. But instead, we see behavioral economics being used to tighten regulation, not to loosen it. Notice that the less-than-complete (narrow) self-interest that behavioralists often emphasize implies that even externalities might be internalized without government policy.

• The EPA instituted a fuel economy labelling requirement that seems intended to remedy all the problems that their later efficiency mandates also targets – don’t they trust their own labelling regulation?

• In dealing with health and safety risks, government does not seem to be more rational than individuals. In practice, worst-case scenarios are over-weighted in regulatory policy; EPA methodology leads to cascading of conservative estimates so that extremely low-likelihood problems can dominate policy. Further, the number of people exposed to a risk, which should be central in formulating policy, is ignored.

• Increases in risk are a sort of loss, and loss aversion kicks in – in the form of alarmist regulatory responses to ebola, terrorism, etc.

• The FDA fears errors of commission much more than errors of omission. [Nonetheless, the evidence base is weak – look how often risks are revealed only after approval; then there are off-label uses, which are quite legal, despite not having been tested in the usual sorts of controlled trials.]

• If organic veggies carry less risk than non-organic vegetables, but they cost more, it could still be better health-wise for people to eat more, non-organic veggies.

• For people to accept a small increase in risk often involves a payment some six times larger than they would pay for the same reduction in risk – a reflection of loss aversion. The “first, do no harm” principle leads to a similar effect in policy. It is often hard to identify victims of the FDA’s failure to approve a useful drug.

• Agencies can have tunnel vision, treating their issue in isolation. In OSHA, for example, regulators are not even allowed to look at the costs of fixing a hazard. One result: costs per life saved vary widely across domains, in ways that seem to be far from optimal.

Shakespeare on the Endowment Effect

My lord, 'tis rated

As those which sell would give: but you well know,

Things of like value differing in the owners

Are prized by their masters: believe't, dear lord,

You mend the jewel by the wearing it.

(Timon of Athens, Act 1, Scene 1, Lines 209-213)

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

Let Helen go:

Since the first sword was drawn about this question,

Every tithe soul, 'mongst many thousand dismes,

Hath been as dear as Helen; I mean, of ours:

If we have lost so many tenths of ours,

To guard a thing not ours nor worth to us,

Had it our name, the value of one ten,

What merit's in that reason which denies

The yielding of her up?

(Troilus and Cressida, Act 2, Scene 2, Lines 1006-1014)

Shakespeare on Being Risk-Loving in the Loss Domain

In my school-days, when I had lost one shaft, 
I shot his fellow of the self-same flight 
The self-same way with more advised watch, 
To find the other forth, and by adventuring both 
I oft found both: I urge this childhood proof, 
Because what follows is pure innocence. 
I owe you much, and, like a wilful youth, 
That which I owe is lost; but if you please 
To shoot another arrow that self way 
Which you did shoot the first, I do not doubt, 
As I will watch the aim, or to find both 
Or bring your latter hazard back again 
And thankfully rest debtor for the first.

(The Merchant of Venice, Act 1, Scene 1, Lines 147-159)

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In As You Like It, Orlando, who has been thrust below his deserved state by his brother Oliver's neglect and enmity, chooses to risk a high probability of serious harm or death by taking on the Duke's mighty wrestler. When Celia and Rosalind try to persuade him against this decision, Orlando replies: 

...let your fair eyes and gentle wishes go with me to my trial; wherein if I be foil'd there is but one sham'd that was never gracious; if kill'd, but one dead that is willing to be so. I shall do my friends no wrong, for I have none to lament me; the world no injury, for in it I have nothing; only in the world I fill up a place, which may be better supplied when I have made it empty.

(As You Like It, Act 1, Scene 2, Lines 299-305)

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We all that are engaged to this loss

Knew that we ventured on such dangerous seas

That if we wrought out life 'twas ten to one;

And yet we ventur'd, for the gain propos'd

Chok'd the respect of likely peril fear'd;

And since we are o'erset, venture again.

Come, we will put forth, body and goods.

(King Henry IV, part 2, Act 1, Scene 1, Lines 238-244)

Shakespeare on Loss Aversion as a Goad to Action

Were't not a shame, that whilst you live at jar,
The fearful French, whom you late vanquished, 
Should make a start o'er seas and vanquish you?
Methinks already in this civil broil
I see them lording it in London streets,
Crying 'Villiago!' unto all they meet.
Better ten thousand base-born Cades miscarry
Than you should stoop unto a Frenchman's mercy.
To France, to France, and get what you have lost;
Spare England, for it is your native coast;
Henry hath money, you are strong and manly;
God on our side, doubt not of victory.

(History of Henry VI, Part II, Act 4, Scene 8, Lines 2799-2810)

Shakespeare on Status-Quo Bias and Loss Aversion

Who would these fardels bear,
To grunt and sweat under a weary life,
But that the dread of something after death-
The undiscover'd country, from whose bourn
No traveller returns- puzzles the will,
And makes us rather bear those ills we have
Than fly to others that we know not of? 

(Hamlet, Act 3, Scene 1, Lines 1769-1775)

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Those that much covet are with gain so fond,
For what they have not, that which they possess
They scatter and unloose it from their bond,
And so, by hoping more, they have but less;
Or, gaining more, the profit of excess
Is but to surfeit, and such griefs sustain,
That they prove bankrupt in this poor-rich gain.

The aim of all is but to nurse the life
With honour, wealth, and ease, in waning age;
And in this aim there is such thwarting strife,
That one for all, or all for one we gage;
As life for honour in fell battle's rage;
Honour for wealth; and oft that wealth doth cost
The death of all, and all together lost.

So that in venturing ill we leave to be
The things we are for that which we expect;
And this ambitious foul infirmity,
In having much, torments us with defect
Of that we have: so then we do neglect
The thing we have; and, all for want of wit,
Make something nothing by augmenting it.

(The Rape of Lucrece, Lines 185-205)

********************************************

Ay, but to die, and go we know not where;
To lie in cold obstruction and to rot;
This sensible warm motion to become
A kneaded clod; and the delighted spirit
To bathe in fiery floods, or to reside
In thrilling region of thick-ribbed ice;
To be imprison'd in the viewless winds,
And blown with restless violence round about
The pendent world; or to be worse than worst
Of those that lawless and incertain thought
Imagine howling: 'tis too horrible!
The weariest and most loathed worldly life
That age, ache, penury and imprisonment
Can lay on nature is a paradise
To what we fear of death.

(Measure for Measure, Act 3, Scene 1, Lines 1353-1367)

Beard and Leitzel (2016) on Compensated Live Kidney Donations

T. Randolph Beard and Jim Leitzel, “Compensated Live Kidney Donations,” 2016; a slightly earlier version, June 17, 2015, is available at http://ssrn.com/abstract=2619934. This paper builds upon Beard and Leitzel (2014).

• To what extent are problems associated with compensation for kidney donations actually problems that already exist in the current system and/or are problems stemming not from the transplant system directly but rather from the organ shortage? The argument presented here is that most problems associated with the provision of donor compensation are either problems in the uncompensated system, too (and tolerably well-addressed), or, are problems of shortage, not of compensation.

• Uncompensated organ donation decisions -- which are not exactly of the everyday variety with meaningful feedback to build upon -- might not be made in a particularly rational fashion. 

• Standard “behavioral” influences, such as risk misperceptions, loss aversion, endowment effects, and present bias, seem to push people in the direction of not being a live organ donor. 

• Safeguards (including the provision of Independent Donor Advocates) are built into the donation system to counter misinformed, rash, or imprudent (psychologically, medically, or otherwise) donations, as well as coerced donations. 

• The introduction of compensation does little in terms of introducing new problems, though it might exacerbate present bias in decisions to donate, or intensify the potential for loss aversion along the "financial expectations" axis.

• One desirable system with compensation would look like the current system, though supplemented with back-loaded compensation, both in-kind and monetary. 

• What are the likely effects of ending the kidney shortage, beyond the lives saved? Nine effects are identified: (1) a diagnosis of End-Stage Renal Disease becomes less devastating; (2) the reluctance to add patients to the transplant list dissipates; (3) the “who gets to live” question loses much of its salience; (4) patient incentives to seek out the black market evaporate; (5) the expansion of acceptability criteria for a kidney ends or is reversed; (6) one risk of donating a kidney declines, in that a donor is assured of being able to acquire one later him or herself; (7) the need for ESRD patients to plead their case for an organ is obviated; (8) family relationships become less strained by an ESRD diagnosis; (9) the incentives to take preventative measures to stave off kidney failure decline.

• So, eight of the dimensions affected by an end to the kidney shortage would alter for the better if the shortage were eliminated -- and the undesirable impact along the ninth dimension simply reflects the fact that an improvement in the treatment of a medical condition implies that the threat represented by the condition diminishes.