The Endowment Effect and the Role of Uncertainty

This paper explains the endowment effect, whereby sellers generally demand considerably more for a good than buyers are prepared to pay, and related anomalies. Many decisions, including nominating buying or selling prices, involve uncertainty, and we assert that people experience negative psychological reactions to uncertainty. These reactions can affect a person's valuation of the various options, biasing the person's actions towards the status quo, thus producing the endowment effect. Our model also proposes positive or negative reactions to unlikely prospects, which are able to explain commonly observed behaviour in the presence of ambiguity. Copyright Blackwell Publishers Ltd and the Board of Trustees of the Bulletin of Economic Research, 2003.