Editing Loss aversion (section)

==Endowment effect==
{{Main|Endowment effect}}

Loss aversion was first proposed as an explanation for the endowment effect—the fact that people place a higher value on a good that they own than on an identical good that they do not own—by Kahneman, Knetsch, and Thaler (1990).<ref>{{cite journal |last1=Kahneman |first1=D. |last2=Knetsch |first2=J. |last3=Thaler |first3=R. |s2cid=154889372 |year=1990 |title=Experimental Test of the endowment effect and the Coase Theorem |journal=[[Journal of Political Economy]] |volume=98 |issue=6 |pages=1325–1348 |jstor=2937761 |doi=10.1086/261737|doi-access=free }}</ref> Loss aversion and the endowment effect lead to a violation of the [[Coase theorem]]—that "the allocation of resources will be independent of the assignment of property rights when costless trades are possible".<ref>{{cite journal |last1=Kahneman |first1=D. |last2=Knetsch |first2=J. |last3=Thaler |first3=R. |s2cid=154889372 |year=1990 |title=Experimental Test of the endowment effect and the Coase Theorem |journal=[[Journal of Political Economy]] |volume=98 |issue=6 |page=1326 |jstor=2937761 |doi=10.1086/261737|doi-access=free }}</ref>

In several studies, the authors demonstrated that the endowment effect could be explained by loss aversion but not five alternatives, namely transaction costs, misunderstandings, habitual [[Bargaining power|bargaining behaviors]], income effects, and [[trophy]] effects. In each experiment, half of the subjects were randomly assigned a good and asked for the minimum amount they would be willing to sell it for while the other half of the subjects were given nothing and asked for the maximum amount they would be willing to spend to buy the good. Since the value of the good is fixed and individual valuation of the good varies from this fixed value only due to sampling variation, the supply and demand curves should be perfect mirrors of each other and thus half the goods should be traded. The authors also ruled out the explanation that lack of experience with trading would lead to the endowment effect by conducting repeated markets.<ref name="Kahneman 1991">{{Cite web|last=Kahneman|first=Daniel|year=1991|title=Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias|url=https://scholar.princeton.edu/sites/default/files/kahneman/files/anomalies_dk_jlk_rht_1991.pdf|access-date=2020-07-19|website=Princeton.edu}}</ref>

The first two alternative explanation are that under-trading was due to transaction costs or misunderstanding—were tested by comparing goods markets to induced-value markets under the same rules. If it was possible to trade to the optimal level in induced value markets, under the same rules, there should be no difference in goods markets. The results showed drastic differences between induced-value markets and goods markets. The [[median]] prices of buyers and sellers in induced-value markets matched almost every time leading to near perfect market efficiency, but goods markets sellers had much higher selling prices than buyers' buying prices. This effect was consistent over trials, indicating that this was not due to inexperience with the procedure or the market. Since the transaction cost that could have been due to the procedure was equal in the induced-value and goods markets, transaction costs were eliminated as an explanation for the endowment effect.<ref name="Kahneman 1991"/>

The third alternative explanation was that people have habitual bargaining behaviors, such as overstating their minimum selling price or understating their maximum bargaining price, that may spill over from strategic interactions where these behaviors are useful to the laboratory setting where they are sub-optimal. An experiment was conducted to address this by having the clearing prices selected at random. Buyers who indicated a [[willingness-to-pay]] (WTP) higher than the randomly drawn price got the good, and vice versa for those who indicated a lower WTP. Likewise, sellers who indicated a lower willingness-to-accept than the randomly drawn price sold the good and vice versa. This incentive compatible value elicitation method did not eliminate the endowment effect but did rule out habitual bargaining behavior as an alternative explanation.<ref name="Kahneman 1991"/>

Income effects were ruled out by giving one third of the participants mugs, one third chocolates, and one third neither mug nor chocolate. They were then given the option of trading the mug for the chocolate or vice versa and those with neither were asked to merely choose between mug and chocolate. Thus, wealth effects were controlled for those groups who received mugs and chocolate. The results showed that 86% of those starting with mugs chose mugs, 10% of those starting with chocolates chose mugs, and 56% of those with nothing chose mugs. This ruled out income effects as an explanation for the endowment effect. Also, since all participants in the group had the same good, it could not be considered a "trophy", eliminating the final alternative explanation.<ref name="Kahneman 1991"/> Thus, the five alternative explanations were eliminated, the first two through induced-value market vs. consumption goods market, the third with incentive compatible value elicitation procedure, and the fourth and fifth through a choice between endowed or alternative good.<ref>{{Cite journal|last=Kahneman|first=Daniel|date=December 1990|title=Experimental Tests of the Endowment Effect and the Coase Theorem|url=https://www.researchgate.net/publication/24108757|journal=The Journal of Political Economy|volume=98|issue=6|pages=1325–1348|doi=10.1086/261737|s2cid=154889372|via=Researchgate.net|doi-access=free}}</ref>