A Reference Price Theory of the Endowment Effect

Acquiring a good seems to increase its value to the owner, as consumers show reluctance to trade away their possessions for similarly valuable money or other goods. The established explanation for this endowment effect is that consumers evaluate potential trades with respect to their current holdings. From this perspective, selling prices exceed buying prices because owners of a good regard its potential loss to be more significant than non-owners regard its potential acquisition. In contrast to this “pain-of-losing” account, we propose a reference price theory which characterizes the endowment effect as the reluctance to trade on unfavorable terms. In this view, consumers evaluate potential trades with respect to salient reference prices, and selling prices (or trading demands) are elevated whenever the most common reference prices — typically market prices — exceed personal valuations. In seven experiments (and eight more summarized in appendices), we show that manipulations which reduce the gap between valuations and reference prices tend to reduce or eliminate the endowment effect. These results support our theory and suggest that the endowment effect is often best construed as an aversion to bad deals, rather than an aversion to losing possessions.