Application of Endowment Effect in Housing and Financial Markets

Zihang Zeng

School of Slavonic and Eastern European Studies, University College London, London, WC1E 6BT, U.K.

Keywords: Endowment Effect, Behavioural Economics, Housing Market.

Abstract: Endowment effect refers to people assigning higher values to items they own compared to those they do not

own. People are influenced by the endowment effect when they overvalue their belongings, which makes

them reluctant to sell or trade them. People may demand greater prices than what is deemed to be fair market

value as a result of this bias, which can lead to less-than-ideal decisions. Consumer behaviour and negotiating

tactics are also impacted. Development of the concept by Thaler, Kahneman and Knetsch hinges largely on

the excessive emotional value attached to losses compared to gains, and together they form a wider part of

the alternative behavioural theory of consumer behaviour challenging standard economic theories. Through

analysis of past experimental and observational research, this paper investigates the presence and impact of

the endowment effect on housing markets and investment behaviours by focusing on the gap between WTA

and WTP, coefficient on loss and impact of real-estate agents in housing; and how endowment effect causes

disposition effect and familiarity bias in investment behaviours.

1 INTRODUCTION

Endowment effect can be defined as ‘The fact that

people often demand much more to give up an object

than they would be willing to pay to acquire it’

(Kahneman et al., 1991). First proposed by Thaler as

part of his alternative consumer behaviour theory

challenging standard economic theories, the famous

coffee mug experiment ran by Kahneman et. al.

solidifies this notion by concluding that based on the

difference between buyer’s willingness to pay (WTP)

price and seller’s willingness to accept (WTA) prices,

mechanics of standard economic theory fails to lead

to convergence to market equilibrium price (Thaler,

1980; Kahneman et al., 1990). One explanation for

this irrational behaviour can be the possessional

attachment formed by sellers to the product, leading

to higher WTP prices than the market price. Loss

aversion is another key mechanic associated with the

development of the concept of endowment effect. It

refers to the fact that the pain of losing something is

psychologically more intense than the pleasure of

gaining something of the same value. It is due to this

greater loss of utility that sellers would require a

higher selling price than the market price of the item

– where the latter is associated with equating the

disutility of losing and the utility of gaining the same

exact item.

This essay will focus on how the mechanics of

loss aversion and psychological attachment functions

when housing and investment decisions are made.

The essay will also aim to provide a comparative

analysis between the two markets.

2 ENDOWMENT EFFECT IN THE

HOUSING MARKET

2.1 Quantitative Evidence from Beijing

Housing Market

Upon investigation of the effect in the residential

housing market, one of the pioneering experimental

studies was conducted by Bao and Gong on the

Beijing housing market (Bao & Gong, 2016). They

conceptualised the endowment effect in the real estate

market as when the Willing To Accept (WTA) prices

reported by seller of a certain housing property to be

higher than the Willing To Pay (WTP) prices reported

by buyer of the same property. Accordingly, their

study investigates whether or not a significant

difference of the two prices can be observed.

Moreover, to enrich their analysis and to better

simulate the highly cyclical nature of the housing

market, Bao and Gong also investigated the impact of

market conditions – overall up- or down-market

640

Zeng, Z.

Application of Endowment Effect in Housing and Financial Markets.

DOI: 10.5220/0014149900004942

Paper published under CC license (CC BY-NC-ND 4.0)

In Proceedings of the 2nd International Conference on Applied Psychology and Mar keting Management (APMM 2025), pages 640-644

ISBN: 978-989-758-791-7

trends of prices - and various buyers and sellers’

characteristics – such as the income and occupation

of the buyers/sellers as well as their social perception

of homeownership - on the magnitude of the

endowment effect (Bao & Gong, 2016).

To better simulate the realities of the housing

market, the researchers created a between subject

study by splitting the participants into roughly equal

groups of buyers and sellers, and to control for

confounding variables, both groups share similar age

and gender characteristics. Following this, interviews

are conducted with individual participants through

collecting their answers to a bi-partite questionnaire.

The first part of the questionnaire focuses on

recording important characteristics of the buyers and

sellers as quantitative dichotomous variables (either

recorded as 0 or 1 corresponding to yes/no to relevant

questions). Several variables of note are ‘income’ –

whether or not the participants’ monthly income is

higher than the average disposable level in Beijing;

‘occupation’ – whether or not the participant works in

the private sector. While the variables of ‘symbol’ –

notion of homeownership as symbol of success - and

‘importance’ – significance of the notion to the

participants. The second part of the questionnaire

provide both buyers and sellers with the imaginary

scenario of trading an imaginary housing property

without consideration to the constraints of their

personal finances and are surveyed of their respective

WTA and WTP prices given different information on

the property. Both buyers and sellers are first given

an evaluation of the current market price of the

property, and then through providing information on

the price of the same property four years and two

years ago, the researchers attempts to establish the

market trend of this property over the past four years

– up-market scenario establish when the price is

observed to rise during the period and conversely

down-market scenario is observed when the price

falls. Eventually when the market trend is established,

the final set of WTA-WTP prices between the up-

market and down-market scenarios are compared

against one another. Moreover, the effort in providing

the participants with multiple scenarios was also a

conscious attempt to train them to acquire more

market experience to mitigate the confounding

impact of market inexperience on the results.

Given this procedure, the researchers first ran a

hypothesis test on the sample mean WTA and WTP

prices and a significant difference was found pointing

to the presence of the endowment effect. It is also

observed that the difference between the two prices is

markedly higher in up-market scenarios by a

significant margin of almost two hundred thousand

RMB. Besides the influence of market trends,

regression analysis ran on the variables of ‘income’,

‘occupation’, ‘symbol’ and ‘success’ also points to a

strong and negative correlation of them and the

magnitude of the difference in prices and hence

endowment effect (Bao & Gong, 2016). Hence,

through their study, Bao and Gong has observed a

significant endowment effect in the housing market

as well as the significant impact of market conditions

and buyers and sellers’ characteristics have on the

effect.

2.2 Observational Evidence from the

Boston Market

For a more grounded and realistic perspective on the

effect’s influence on the housing market, Genesove

and Mayer’s observation study on the Boston

condominium market can offer more grounded

insights into the interaction between sellers’ initial

asking price, the loss aversion mechanic and the

eventual adjusted market price of a certain property

(Genesove & Mayer, 2001). The researchers

monitored and analysed the listing and selling prices

data from a well-defined and rather affluent

neighbourhood in downtown Boston over the period

of 1990-97. To investigate the realistic functioning of

the loss aversion mechanic from the sellers’ side, they

first defined the variable of ‘LOSS’ as the difference

between previous selling price and potential selling

price in this period (Genesove & Mayer, 2001). From

their analysis of over 3000 properties sold, a

specified range of ‘coefficient on loss’ (0.25-0.35) –

parameter measuring the percentage to which seller

would raise or lower their asking prices based

percentage change of the variable LOSS – is observed

(Genesove & Mayer, 2001). Challenging standard

economic theory’s suggestion of eventual

‘correction’ to the market price, the researchers have

observed that although the eventual coefficient on

loss of properties sold were lower – between 3 and 18

percent – the loss aversion mechanic is still persistent

(Genesove & Mayer, 2001). They explained this

phenomenon as sellers more sensitive to losses would

have withdrawn from the market leaving those who

are less sensitive to losses eventually selling their

properties. Additionally, they also observed that

despite having a lower coefficient on loss than

average consumers, investors of investment

properties still exhibited evidence of the endowment

effect by having a positive coefficient. Hence,

Genesove and Mayer’s study further validifies the

presence of endowment effect in the housing market

by validating the significance of the loss aversion

Application of Endowment Effect in Housing and Financial Markets

641

mechanic involved with selling housing properties,

while valuable insight towards presence of the effect

amongst experienced traders was also observed.

2.3 Influence of Real Estate Agents on

the Effect

Furthermore, another common perspective of the

real-estate market is the employment of agents by

both buyers and sellers. Tomal study provides insight

into how such agents employed could impact the

magnitude of endowment effect in the market (Tomal,

2024). Akin to the experiment by Bao and Gong,

Tomal mainly investigated the effect through the

difference between WTA and WTP, and designed his

between-subject study in a similar bipartite

questionnaire (Bao & Gong, 2016; Tomal, 2024).

Tomal, on top of the market trend scenarios suggested

by Bao and Gong, added the participation of agent on

both buyers’ and sellers’ sides to observe the impact

the magnitude of the gap between WTA and WTP.

Findings from the results indicate that the difference

is still positive and statistically significant after the

introduction of the agents, illustrating that agents do

not eliminate the endowment effect. Results also

indicate that seller’s employment of agent has, given

that the buyer does not employ one, a statistically

significant positive impact on the endowment effect;

however, when both sides simultaneously employ

agents, the effect is insignificant. This, the

researchers concluded, was due to the commission

charged by agents are regarded by sellers as a

particularly negative loss. Hence, Tomal study

verifies that the employment of real estate agent – a

common occurrence in the market – intensifies the

loss aversion mechanic involved with selling housing

properties.

3 ENDOWMENT EFFECT

OBSERVED IN FINANCIAL

MARKETS

3.1 Pioneering Empirical Evidence

from Disposition Effect

One prominent implication of the endowment effect

in investment behaviours is perhaps with the

disposition effect – defined as tendency of investors

to ‘hold losing investment for too long, and sell

winning investment too soon’ (Odean, 1998).

Barberis and Xiong clarifies that the decision of an

investor to either sell or hold a stock depends on

associated ‘realisation utility’, and they attach a

highly positive emotional value towards realising

gains and conversely selling stocks at a loss are

particularly frowned upon – echoing the loss aversion

mechanic *Barberis & Xiong, 2009). Empirical and

observational perspectives on disposition effect

provided by Odean seeks to verify this mechanic by

collecting trading data of 10,000 accounts between

1987-93 from a large brokerage house (Odean, 1998).

Odean classified gains and losses on stocks as either

‘realised’ – already obtained from selling the stock –

and ‘paper’ – not obtained but based on calculations

of the difference between current and initial purchase

price (Odean, 1998). Consequently, they calculated

the ratio of proportions of gains realised (PGR) –

realised gains divided by realised plus paper gains –

and proportions of losses realised (PLR) – realised

losses divided by realised plus paper losses.

Through a two sample t-test, significant

difference between PGR and PLR is found, with the

former being significantly higher than the latter,

indicating the disposition effect. In addition, Odean

also found that infrequent traders had a more

significant difference between PGR and PLR than

frequent traders, alluding to market inexperience

exacerbating the disposition effect. Consequently, as

there are fewer potential sellers of losing stocks, their

prices would fall further, which only aggravates loss

aversion and carries on the vicious cycle;

simultaneously the reverse is true for gaining stocks.

Interestingly, Odean observed a notable exception to

the trend in December, since investors are

incentivised to sell more losing stocks in order to

escape higher amounts paid in capital gains taxes at

the end of the year. Thus, through the loss aversion

mechanic, endowment effect exerts impact on

investors’ selling of stocks by causing them to be

more inclined to sell gaining rather than losing stocks

and hence impacting stock prices.

3.2 Manifestation in Form of

Familiarity Bias

Moreover, another prominent illustration of the

endowment effect in investment behaviours is

familiarity bias – overinvestment in familiar stocks

that are seen as ‘safer options’ – as the latter exhibit a

high degree of loss aversion and tendency to favour

already-owned assets (Lei & Mathers, 2024).

Analysing the dataset collected on investment

behaviours from US’ 2019 Survey of Consumer

Finances, Lei and Mathers analysed the relationship

between social-economic background of US

investors – age, gender, level of education, presence

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of financial advice - against their tendency to

diversify their personal investment portfolios. It is

found that there is a prevalent trend of under-

diversification of portfolios amongst investors, who

shares tendencies to overinvest in employer

company’s stock or in securities based in home

country (the latter also known as ‘home bias’). Well-

educated, financially well-advised employees of large

companies were shown to invest more in employer’s

stocks – likely due to presence of them in their

pension plans - while financial literacy and personal

risk adverseness are negatively correlated with ‘home

bias’. Thus, the effects of loss aversion and tendency

to hold on to investments already owned and familiar

with indicates that the endowment effect also asserts

itself in investment decisions in form of the

familiarity bias.

4 DISCUSSION

4.1 Comparative Analysis of

Endowment Effect’s Significance in

Housing and Financial Markets

According to the Kahneman et. al. conceptualisation

of endowment effect, the notion is largely hinged on

loss aversion mechanism during decision-making –

due to the psychological pain of losing something

being greater than gaining the same item, people often

require greater compensation for their losses

(Kahneman et al., 1991). On the one hand, the two

markets share a similar loss-aversion mechanic as it

can be arguably observed in the housing market as the

sellers only accepting asking prices (WTA) higher

than equilibrium market price. For financial markets,

the same mechanic is present considering investors

are less inclined to realise losses made on investments

compared to gains. Another similarity is that the

traders in both market tend to form a strong

psychological attachment to their housing properties

or investments, where the former is highlighted as a

strong emotional attachment whilst the latter being

illustrated more as the tendency to invest in

companies and markets that one is attached too. An

explanation for the similarity of the observation is

that both housing and investment decisions tend to

constitute a sizeable proportion on one’s disposable

income and savings, and given the high sunk cost

involved (Thaler, 1980). Moreover, turning away

from one’s ‘endowment’ of housing property or

investment portfolio may provoke the ‘regret

avoidance’ mechanic (Zeelenberg & Pieters, 2004).

Consequently, consumers would refuse to turn away

from the ‘norm’ – that is the ‘endowment’ – in

anticipation for potential regret in doing so.

On the other hand, the magnitude of the effect

differs between the two markets when considering the

behaviour of experienced traders in respective

markets. Through their observational study on the

Boston condominium market, Genesove and Mayer

have observed that experienced investors in

investment properties have a markedly lower

coefficient on loss compared to regular homeowners,

as they points to a richer market experience leading

to the observed lower level of risk aversion

(Genesove & Mayer, 2001). Magnitude of the effect

is, in comparison, more prevalent amongst investors

of all backgrounds in the financial market as observed

by Odean observational study on more than 3000

investors of various backgrounds (Odean, 1998).

4.2 Future Research

It is observed during the research process that all

preceding efforts were rather limited in their scope.

To start with, the established recent research of the

effect’s presence in the housing market have only

been done in Poland and China, where, arguably, both

markets have certain special properties (Bao & Gong,

2016; Tomal, 2024). When Bao and Gong were

sampling data from the Beijing market, the Chinese

housing industry was still in rapid growth with ever-

growing housing prices and ever-increasing volume

of transactions. However, since given context of the

real estate crisis since 2020 experienced in China,

prices have fell and stagnated significantly with

falling housing prices and readily falling numbers of

properties sold. While Tomal’s 2024 research

similarly highlighted a gloomy trend in domestic

market. Thus, it is questionable whether similar

magnitude of the effect can be observed in different

international markets where it is not as dynamic and

fast growing as pre-COVID 19 Chinese market, or in

others where the recovery has been much more rapid.

Therefore, the current research on housing market’s

endowment effect is largely limited in its

international outlook, and for a more consistent

conclusion to be drawn, more research must be done

in markets across the world especially given the

seismic downward shock that COVID-19 provided to

the market. As for the financial markets, although a

multitude of research such as Barberis and Xiong

have elaborated the mechanics behind endowment

effect’s impacts on investment, there is a lack of

quantitative research on a comparative scale to

preceding ones performed by Odean (Barberis &

Application of Endowment Effect in Housing and Financial Markets

643

Xiong, 2009). Thus, conducting quantitative research

through bipartite questionnaire or replicating similar

observational study to Odean’s can further solidify

and enrich the study of the effect.

5 CONCLUSION

In conclusion, endowment effect refers to the fact that

people often demanded much more to give up an

object compared to the amount that they are willing

to pay for it. Being strongly associated with the

concept of loss aversion – the stronger disutility

involved in giving up an item - and psychological

attachment of ownership, this concept seeks to serve

as an alternative theorem to standard economic theory

in explaining why various markets cannot converge

to identified market equilibrium prices and quantities.

In the housing market, it is observed through the

difference between the minimum WTA prices from

sellers and maximum WTP prices from sellers,

property sellers through a certain coefficient on loss

would adjust their asking prices according with

projected losses, which would eventually lead the

market to converge to a higher price than the

equilibrium level, and the presence of real-estate

agent might act to raise such ratio causing a more

prominent effect. In the financial market, endowment

effect act as a significant cognitive bias, whose loss-

aversion heuristic causes investors to overcapitalised

on projected gains in assets as well as constructing an

under-diversified portfolios that is in accordance with

an investors’ ‘endowment’ of current home country

or employer. Hence, endowment effect is prevalent

phenomena observed in various economic behaviours

and act as a component of an alternative theorem of

consumer behaviour.

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