Endowment Effect as a Rational Strategy Part 2: Don't Be A Sucker

Many seemingly irrational decision-making biases can be rational in some settings which differ from typical experimental settings. For example, psychologists and economists scratch their heads that in single-round games, people will expend resources to punish wrongdoers, even when there is no net benefit for the punisher. But in multi-round games, expending resources to punish wrong-doers may actually provide a net benefit and act as a deterrent against future wrongdoing. The irrationality arises because some of these behaviors are rigid with respect to setting, and even in single-round games where we'll never see people again (e.g. someone who cut you off on the freeway) we continue to punish wrongdoers regardless of setting or expected net benefit.

The endowment effect is a bias where we place irrationally high value on things already in our possession, as opposed to the open market. ("That car over there is a clunker, he'll never get three grand for it. But mine? Same year, same condition? Five grand easy. Great car.") Curiously, a group of hunter-gatherers without access to markets (i.e., roads) do not show the endowment effect. Their close relatives who do have access to markets, DO show the endowment effect. I speculated that this could be because the endowment effect is in fact a defense against information asymmetry. Somebody who buys and sells cars for a living knows how much your car is worth more than you do, and they can screw you. Consequently the endowment effect gives you a cushion. If you've never been screwed in an open market before, you don't develop this defense. (So goes my theory anyway.)

Sure enough, Data Colada brings us a paper by Weaver and Frederick which strongly suggests it's trying to avoid a bad deal which is what motivates the endowment effect.