The Endowment Effect as blessing

Frenkel, Sivan and Heller, Yuval and Teper, Roee (2013): The Endowment Effect as blessing.

Abstract

We study the idea that seemingly unrelated behavioral biases can coevolve if they jointly compensate for the errors that any one of them would give rise to in isolation. We pay specific attention to barter trade of the kind that was common in prehistoric societies, and suggest that the “endowment effect” and the “winner's curse” could have jointly survived natural selection together. We first study a barter game with a standard payoff-monotone selection dynamics, and show that in the long run the population consists of biased individuals with two opposed biases that perfectly offset each other. In this population, all individuals play the barter game as if they were rational. Next we develop a new family of “hybrid-replicator” dynamics. We show that under such dynamics, biases survive in the population for a long period of time even if they only partially compensate for each other and despite the fact that the rational type's payoff is strictly larger than the payoffs of all other types.

• Item Type: MPRA Paper
• Language: English
• Keywords: Endowment Effect, Winner's Curse, Bounded Rationality, Evolution.
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C73 - Stochastic and Dynamic Games ; Evolutionary Games ; Repeated Games

References

Ashenfelter, O., and D. Genesove (1992): Testing for Price Anomalies in Real-Estate Auctions, The American Economic Review (Papers and Proceedings), 82(2), 501-505.

Aumann, R. (2008): Rule Rationality vs. Act Rationality, The Hebrew University, Center for the Study of Rationality DP 497.

Ball, S. B., M. H. Bazerman, and J. S. Carroll (1991): An Evaluation of Learning in the Bilateral Winner's Curse, Organizational Behavior and Human Decision Processes, 48(1), 1-22.

Bazerman, M. H., and W. F. Samuelson (1983): I Won the Auction But Don't Want the Prize, Journal of Conict Resolution, 27(4), 618-634.

Bernardo, A. E., and I. Welch (2001): On the Evolution of Overcondence and Entrepreneurs, Journal of Economics & Management Strategy, 10(3), 301-330.

Blecherman, B., and C. Camerer (1998): Is There a Winner's Curse in Baseball Free Agency: Evidence from the Field, California Institute of Technology Social Science Work- ing Paper 24.

Bokhari, S., and D. Geltner (2011): Loss Aversion and Anchoring in Commercial Real Estate Pricing: Empirical Evidence and Price Index Implications, Real Estate Economics,39(4), 635-670.

Boone, A. L., and J. H. Mulherin (2008): Do Auctions Induce a Winner's Curse: New Evidence from the Corporate Takeover Market, Journal of Financial Economics, 89(1), 1-19.

Capen, E., R. Clapp, and W. Campbell (1971): Competitive Bidding in High-Risk Situations, Journal of Petroleum Technology, 23(6), 641-653.

Cassing, J., and R. W. Douglas (1980): Implications of the Auction Mechanism in Baseball's Free Agent Draft, Southern Economic Journal, 47(1), 110-121.

Dasgupta, P., and E. Maskin (2005): Uncertainty and Hyperbolic Discounting, The American Economic Review, 95(4), 1290-1299.

Dekel, E., J. C. Ely, and O. Yilankaya (2007): Evolution of Preferences, Review of Economic Studies, 74(3), 685-704.

Ely, J. C. (2011): Kludged, American Economic Journal: Microeconomics, 3(3), 210-231.

Eyster, E., and M. Rabin (2005): Cursed Equilibrium, Econometrica, 73(5), 1623-1672.

Fershtman, C., K. L. Judd, and E. Kalai (1991): Observable Contracts: Strategic Delegation and Cooperation, International Economic Review, 32(3), 551-559.

Genesove, D., and C. Mayer (2001): Loss Aversion and Seller Behavior: Evidence from the Housing Market, The Quarterly Journal of Economics, 116(4), 1233-1260.

Grosskopf, B., Y. Bereby-Meyer, and M. Bazerman (2007): On the Robustness of the Winner's Curse Phenomenon, Theory and Decision, 63, 389-418, 10.1007/s11238-007-9034-6.

Güth, W., and H. Kliemt (1998): The Indirect Evolutionary Approach, Rationality and Society, 10(3), 3770399.

Güth, W., and M. Yaari (1992): Explaining Reciprocal Behavior in Simple Strategic Games: An Evolutionary Approach, in Explaining Process and Change: Approaches to Evolutionary Economics, ed. by U. Witt, pp. 2334. The University of Michigan Press, Ann Arbor. 25.

Hansen, R. G. (1985): Empirical Testing of Auction Theory, The American Economic Review, 75(2), 156-159.

Hansen, R. G. (1986): Sealed-Bid versus Open Auctions: The Evidence, Economic Inquiry, 24(1), 125-142.

Harrison, G. W., and J. A. List (2004): Field Experiments, Journal of Economic Literature, 42(4), 1009-1055.

Haviland, W., H. Prins, D. Walrath, and B. McBride (2007): Anthropology: The Human Challenge. Wadsworth/Thomson Learning, 12, illustrated edn.

Heifetz, A., and E. Segev (2004): The Evolutionary Role of Toughness in Bargaining, Games and Economic Behavior, 49(1), 117-134.

Heifetz, A., C. Shannon, and Y. Spiegel (2007a): The Dynamic Evolution of Preferences, Economic Theory, 32, 251286, 10.1007/s00199-006-0121-7.

Heifetz, A., C. Shannon, and Y. Spiegel (2007b): What to Maximize If You Must, Journal of Economic Theory, 133(1), 31-57.

Heifetz, A., and Y. Spiegel (2001): The Evolution of Biased Perceptions, Tel Aviv University Working Paper.

Heller, Y. (2011): Overcondence and Diversication, mimeo.

Hendricks, K., R. H. Porter, and B. Boudreau (1987): Information, Returns, and Bidding Behavior in Ocs Auctions: 1954-1969, The Journal of Industrial Economics, 35(4), 517-542.

Herskovits, M. J. (1952): Economic Anthropology: A Study in Comparative Economics. A.A. Knopf, New York, Originally published in 1940 as The Economic Life of Primitive Peoples.

Horowitz, J. K., and K. E. McConnell (2002): A Review of WTA/WTP Studies, Journal of Environmental Economics and Management, 44(3), 426-447.

Huck, S., G. Kirchsteiger, and J. Oechssler (2005): Learning to Like What You Have Explaining the Endowment Eect, The Economic Journal, 115(505), 689-702.

Isoni, A., G. Loomes, and R. Sugden (2011): The Willingness to PayWillingness to Accept Gap, the Endowment Eect, Subject Misconceptions, and Experimental Procedures for Eliciting Valuations: Comment, The American Economic Review, 101(2), 991-1011.

Jehiel, P., and F. Koessler (2008): Revisiting games of incomplete information with analogy-based expectations, Games and Economic Behavior, 62(2), 533-557.

Kagel, J. H., R. M. Harstad, and D. Levin (1987): Information Impact and Allocation Rules in Auctions with Aliated Private Values: A Laboratory Study, Econometrica, 55(6), 1275-1304.

Kagel, J. H., and D. Levin (1986): The Winner's Curse and Public Information in Common Value Auctions, The American Economic Review, 76(5), 894-920.

Kagel, J. H., and D. Levin (2002): Common Value Auctions and the Winner's Curse.Princeton University Press.

Kagel, J. H., and A. E. Roth (eds.) (1997): The Handbook of Experimental Economics. Princeton University Press.

Kahneman, D., J. L. Knetsch, and R. H. Thaler (1990): Experimental Tests of the Endowment Eect and the Coase Theorem, Journal of Political Economy, 98(6), 1325- 1348.

Kahneman, D., J. L. Knetsch, and R. H. Thaler (1991): Anomalies: The Endowment Eect, Loss Aversion, and Status Quo Bias,The Journal of Economic Perspectives, 5(1), 193-206.

Kahneman, D., and D. Lovallo (1993): Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking, Management Science, 39(1), 17-31.

Knetsch, J., F.-F. Tang, and R. Thaler (2001): The Endowment Eect and Repeated Market Trials: Is the Vickrey Auction Demand Revealing?, Experimental Economics, 4, 257269, 10.1007/BF01673537.

Lind, B., and C. R. Plott (1991): The Winner's Curse: Experiments with Buyers and with Sellers, The American Economic Review, 81(1), 335-346.

List, J. A. (2003): Does Market Experience Eliminate Market Anomalies?, The Quarterly Journal of Economics, 118(1), 41-71.

List, J. A. (2004): Neoclassical Theory Versus Prospect Theory: Evidence from the Marketplace, Econometrica, 72(2), 615-625.

Massey, C., and R. H. Thaler (2010): The Loser's Curse: Overcondence vs. Market Eciency in the National Football League Draft, SSRN eLibrary.

Mead, W. J. (1967): Natural Resource Disposal Policy - Oral Auction versus Sealed Bids, Natural Resources Journal, 7(2), 194-224.

Mead, W. J., A. Moseidjord, and P. E. Sorensen (1983): The Rate of Return Earned by Lessees under Cash Bonus Bidding for OCS Oil and Gas Leases, The Energy Journal, 4(4), 37-62.

Nöldeke, G., and L. Samuelson (2005): Information-Based Relative Consumption Effects: Correction, Econometrica, 73(4), 1383-1387.

Plott, C. R., and K. Zeiler (2005): The Willingness to Pay-Willingness to Accept Gap, the "Endowment Eect," Subject Misconceptions, and Experimental Procedures for Eliciting Valuations, The American Economic Review, 95(3), 530-545.

Plott, C. R., and K. Zeiler (2007): Exchange Asymmetries Incorrectly Interpreted as Evidence of Endowment Eect Theory and Prospect Theory, The American Economic Review, 97(4), 1449-1466.

Plott, C. R., and K. Zeiler (2011): The Willingness to Pay-Willingness to Accept Gap, the Endowment Eect, Subject Misconceptions, and Experimental Procedures for Eliciting Valuations: Reply, The American Economic Review, 101(2), 1012-1028.

Polanyi, K. (1957): The Economy as Instituted Process, in Trade and Market in the Early Empires: Economies in History and Theory, ed. by K. Polanyi, C. M. Arensberg, and H. W. Pearson., pp. 243-270. The Free Press.

Robson, A. J., and L. Samuelson (2007): The Evolution of Intertemporal Preferences, The American Economic Review, 97(2), 496-500.

Robson, A. J., and L. Samuelson (2009): The Evolution of Time Preference with Aggregate Uncertainty, The Amer- ican Economic Review, 99(5), 1925-1953.

Roll, R. (1986): The Hubris Hypothesis of Corporate Takeovers, The Journal of Business, 59(2), 197-216.

Sahlins, M. D. (1972): Stone Age Economics. Aldine.

Samuelson, L. (2004): Information-Based Relative Consumption Eects, Econometrica, 72(1), 93-118.

Samuelson, L. (2005): Economic Theory and Experimental Economics, Journal of Economic Literature, 43(1), 65-107.

Samuelson, W., and M. Bazerman (1985): The Winner's Curse in Bilateral Negotiations, in Research in Experimental Economics, ed. by V. Smith, vol. 3. Greenwich, CT: JAI Press.

Thaler, R. (1980): Toward a Positive Theory of Consumer Choice, Journal of Economic Behavior and Organization, 1(1), 39-60.

Waldman, M. (1994): Systematic Errors and the Theory of Natural Selection, The American Economic Review, 84(3), pp. 482-497.

Winter, E., I. Garcia-Jurado, and L. Mendez-Naya (2009): Mental Equilibrium and Rational Emotions, The Hebrew University, Center for the Study of Rationality DP 521.