Kumar, Zilvinas
Does Market Experience Eliminate Market Anomalies?
John A List
Summary
List hypothesizes that the market experience can eliminate the anomaly known as the
endowment effect.1 While endowment effect may appear in experiments or situations in which
agents are inexperienced, as agents gain market experience they overcome this “flaw” in their
thinking and behave “rationally.”
Methods
Overview
List collected his data by examining trading patterns of sports memorabilia at a sports
card show in Orlando, FL, and trading patterns of collector pins in a market constructed by Walt
Disney World at Epcot Center, also in Orlando. List claims that such a method of data collection
is advantageous because it is realistic and unobtrusive. One problem cited by List is determining
which direction the path of causation follows. The correlation between reduced endowment
effect and market experience may be exhibited because the subjects learn from their experience
to behave more rationally (treatment effect). However, the cause chain may also flow in reverse:
Certain subjects are simply more rational by nature, they naturally do not exhibit the endowment
anomaly, and as a result of this fact they are more willing to buy and sell goods at the market
prices, thus gaining “experience.” Whereas other subjects may be more irrational by nature,
naturally exhibiting the endowment effect, and as a result demand anomalously high prices to
induce them to sell. Thus they sell less and become less “experienced” (selection effect). To
eliminate this ambiguity, List reexamined the same subjects a year later, to see if their behavior
was different as a result of their increased experience during that year.
Phase I, The Sports Card Market
At the sports memorabilia market, subjects were randomly given one of two more or less
equally valuable sports cards (we will label these good A and good B). They filled out a survey,
and were then asked whether or not they wanted to exchange their good for the other good.
Given that the two goods were initially assigned randomly, we expect that exactly fifty percent
1
The endowment effect is a name given to a certain seeming contradiction to the standard assumption that
individuals have stable, well defined preferences, and make rational decisions in accordance with those preferences.
The endowment effect, first discovered and labeled by Thaler (1980), refers to the fact that individuals demand
much more to give a good up than they would pay to acquire it. This, of course, seems to contradict the assumption
that individuals have stable valuations of goods. Although it can be argued that the endowment effect is not
inconsistent with stable preferences, but simply that a stable feature of humans’ preferences is that the disutility of
having to give something up is greater than the utility of acquiring it. Kahneman and Tversky labeled this
hypothesized property loss aversion. Another related concept is what Samuelson and Zeckhauser (1988) called
status quo bias – namely, they hypothesized that people simply have a preference for maintaining the status quo,
thus once endowed with an object they are resistant to both buying more of it or selling it at the current market price.
of people were assigned the good they preferred less (each person has a fifty percent chance of
receiving their favored good, whichever of the two that is), thus we expect a trading volume of
fifty percent. A volume of less than this would constitute evidence for the existence of an
endowment effect – people value goods more when when they have them. The closer the trading
volume is to fifty percent, the lesser the magnitude of the endowment effect. List thus tried to
estimate the magnitude of the endowment effect within two subject subsets: i) Card dealers with
booths at the convention (whose average level of experience was relatively high, as measured by
a question on the survey regarding average number of trades per month) and ii) Non-Dealers
(whose average level of experience was relatively low). List also calculated the magnitude of the
endowment effect within subsets of the non-dealers – list split the non-dealers up into
“experienced” and “inexperienced” categories based on whether they made more or fewer than 6
trades per month (the median number of trades per month among non-dealers).
Phase II, The Pin Market
The second phase of the study, conducted at the pin market, was conducted so as to avoid
any possible biases specific to the sports memorabilia market. The methods used in this phase
were similar, and so I won’t go into detail about them.
Phase III, Return to the Sports Card Market
In the third phase, List returned to the sports card market a year later and conducted the
same experiment (with two new goods, of course) on the subjects he’d tested earlier. The
purpose of this, recall, was to eliminate the possibility of a selection effect.
Results
Overall, the results confirmed the hypothesis that market experience reduces the
magnitude of the endowment effect. In phase I, percentage of trades conducted by dealers
numbered 43.6% and 45.7%, both close to the theoretically predicted 50%, whereas percentage
of trades among non-dealers numbered 20% and 25%. Alternately, the null hypothesis had a pvalue of .32 among dealers (32% probability that there is no endowment effect among dealers)
and a p-value of .001 among non-dealers (.1% probability that there is no endowment effect
among non-dealers). Finally, regression models estimated a statistically significant positive
effect of trading experience on number of trades among non-dealers. The results in phase II
were similarly supportive of the hypothesis, suggesting that the hypothesis is robust across
different types of markets. Results in phase III, again, were supportive, however List mentions
the possibility of a selection bias – namely, only those subjects who remained interested in sports
card trading returned to participate in the later experiment. However, statistical tests conducted
by List indicated that this was not a major problem.
Relevance to Markets
To investigate the potential impact of an endowment effect on equilibrium social welfare,
List constructed a theoretical partial equilibrium model with two goods in which some
consumers were “experienced” (exhibiting no endowment effect) and some were
“inexperienced” (exhibiting an extreme form endowment effect for good 1 – namely, they
refused to ever lower their consumption of good 1). The result was an equilibrium that was
considerably less efficient than the normal competitive case without endowment effects;
furthermore, most of the efficiency loss was suffered by the inexperienced consumers. However,
the situation may not be so severe, for if even some economic agents are rational, strategic
interaction may yield a form of Coase’s invariance theorem. List gives the following example.
Suppose Gary and Milton’s valuations of a lamp are given by the following table:
Now if the lamp is initially given to Milton, no exchange will occur, for even though Gary’s
WTA is higher than Milton’s, Gary does not value the lamp at 200 until it is already in his
possession. Thus, an inefficiency results – the lamp is not being distributed to the person who
values it most. However, suppose there is a third party, John, who is profit maximizing. John
can purchase the lamp from Milton at 160 and “lend” it to Gary. Now that Gary has the lamp, its
value to him will shoot up to 200, and John can threaten to take it away unless Gary pays him the
200. Thus the lamp will end up being distributed to the person who values it most, and John will
make a profit for his unselfish altruism.
Conclusion and Alternate Theory
In conclusion, Lists hypothesis is confirmed. I propose, however, a potential rational
explanation of the endowment effect. The endowment effect may be viewed as rational, if one
takes it to be simply a form of risk aversion: You may not know how valuable something is to
you until you have it, thus you undervalue goods when purchasing them, because you are
discounting for the possibility that the good may not be as valuable as anticipated.