Wednesday, March 04, 2009
The endowment effect and trade proposals
Posted by Marco Fujimoto at 4:01amThe endowment effect states that people place a higher value on items they already own as opposed to items they want but do not own. Victor Wang touched upon this concept briefly in this article, and I want to elaborate on it, since I think it is a bias that occurs frequently, yet is one that is frequently overlooked. This is somewhat similar to the prospect theory concept, loss aversion, proposed by Amos Tversky and Daniel Kahneman. Allow me to present a study to help explain this phenomenon in greater detail.
Ziv Carmon and Dan Ariely conducted a field survey amongst randomly picked students of Duke University. The students were asked for the highest price they would pay for a ticket to the tournament, assuming they didn't already have a ticket (buying price). A second question asked for the lowest price they would agree to sell a ticket for, assuming they owned one (selling price). In addition to these questions, two factors were manipulated across the group of students, and were incorporated into the initial scenario. The first factor was the original face value of the ticket ($10, $30 or $100) while the second factor was the importance of the game (a regular season game or the NCAA championship game).
Carmon and Ariely found that the selling price of a ticket was considerably higher than the buying price. On average, the lowest price at which owners would sell a ticket was $2,411 while the highest price of those seeking to buy a ticket was $166, a difference of $2,245. The results also showed that the significance of a game had a greater impact on selling price while the original face value of a ticket had greater impact on buying price.
These findings suggest that buying price corresponds more closely to variables relating to the expenditure while selling price corresponds more closely to factors relating to the attitude toward surrendering a ticket (e.g. the significance of the game). Students also gave explanations for their responses, and the most common explanations for the selling price scenario were "this is a once in a lifetime opportunity" and "I will never forgive myself if I end up missing a great game". On the other hand, the most common explanation for the buying price scenario was "there are lots of other things I could do with my money". These comments further support the idea that buyers and sellers focus on different aspects of an exchange. To reiterate, buyers tend to focus more on the money they would pay for an item whereas sellers concentrate on the act of giving up the item.
In the aforementioned article linked above, Victor mentions how the endowment effect can often delay or even prevent a trade from occurring. Without a doubt this effect can help explain various situations. Realize that in sending a trade proposal, you are effectively acting as the buyer and the opposing manager is acting as the seller. And unless your trade proposal is one that your opposing manager had already been targeting, I suspect that his initial reaction would be that of reluctance. According to the findings of Carmon and Ariely, this makes perfect sense as the owner of an item values his possessions at a higher price since they concentrate more on the loss of the item. So the manager, at least at first glance, will tend to overvalue those players you ask for because he has instinctively inflated the value of those players simply because he owns them, and he doesn't really want to give them up. The flip-side of this, of course, is that your proposal might be garbage to begin with because, according to Carmon and Ariely, as a buyer, you are concentrating on the amount you would have to pay for the item. So as a result, you may be offering the absolute bare-minimum (not that there's anything horribly wrong with that).
I think awareness of this concept can be very useful, not just in terms of assigning a proper value to your own players, but in possibly manipulating your opponent into making mistakes. During trade talks, you can phrase your messages in a manner that frames your proposal in terms of what your opponent will gain rather than what he will lose. Show the opposing manager what stats, categories or points he will be gaining as opposed to losing. In addition to this, focus on the notion that some of his stats will be replaced by whomever his replacement player is. Remember, as a seller, the opposing manager is already overvaluing his players. But in order to get a trade done without overpaying, you need to help release him of this instinctive attachment and awareness of the endowment effect, combined with carefully chosen words and numbers, can help immensely.
Marco thanks everyone for reading, apologizes in advance for his tardiness and requests that readers be patient in awaiting replies. He welcomes all questions, comments and thoughts on any topic, baseball or otherwise, here.
I think there’s another factor at work here as well. If we’re heading into a draft, and I think Ryan Braun is going to hit 45 HR this year, and you think he’s going to hit 35 HR, I’m much more likely to end up with him on my team. I value him higher, so I’m more likely to pick him early or pay more in an auction.
So when you offer me a trade for him, you’re trading for an expected 35 HR, whereas I’m looking at giving up 45 HR. I think this is a bigger effect than the endowment effect, on fantasy baseball at least. I don’t know what to call it, but it’s similar to the “winner’s curse”, right?