what is the endowment effect 
the endowment effect refers to an emotional bias that causes individuals to value an owned object higher often irrationally than its market value understanding the endowment effectin behavioral finance the endowment effect or divestiture aversion as it is sometimes called describes a circumstance in which an individual places a higher value on an object that they already own than the value they would place on that same object if they did not own it this type of behavior is typically triggered with items that have an emotional or symbolic significance to the individual however it can also occur merely because the individual possesses the object in question example of the endowment effectlet s look at an example an individual obtained a case of wine that was relatively modest in terms of price if an offer were made at a later date to acquire that wine for its current market value which is marginally higher than the price that the individual paid for it the endowment effect might compel the owner to refuse this offer despite the monetary gains that would be realized by accepting the offer so rather than take payment for the wine the owner may choose to wait for an offer that meets their expectation or drink it themselves the actual ownership has resulted in the individual overvaluing the wine similar reactions driven by the endowment effect can influence the owners of collectible items or even companies who perceive their possession to be more important than any market valuation under the restrictive assumptions of rational choice theory which undergirds modern microeconomic and finance theory such behavior is irrational behavioral economists and behavior finance scholars explain such allegedly irrational behavior as a result of some sort of cognitive bias that warps the individuals thinking according to these theories a rational individual should value the case of wine at exactly the current market price since they could purchase an identical case of wine at that price if they were to sell or otherwise give up the case that they own already the endowment effect makes investors hold onto specific securities longer than they should without a clear exit plan investors are strongly susceptible to the endowment effect the endowment effect triggersresearch has identified two main psychological reasons as to what causes the endowment effect the endowment effect impactpeople who inherit shares of stock from deceased relatives exhibit the endowment effect by refusing to divest those shares even if they do not fit with that individual s risk tolerance or investment goals and may adversely impact a portfolio s diversification determining whether or not the addition of these shares negatively impacts the overall asset allocation is appropriate to reduce negative outcomes the endowment effect bias applies outside of finance as well a well known study that exemplifies the endowment effect and has been replicated successfully starts with a college professor who teaches a class with two sections one that meets mondays and wednesdays and another that meets tuesdays and thursdays the professor hands out a brand new coffee mug with the university s logo emblazoned on it to the monday wednesday section for free as a gift not making much of a big deal out of it the tuesday thursday section on the other hand receives nothing a week later the professor asks all of the students to value the mug the students who received the mug on average put a greater price tag on the mug than those who did not when asked what would be the lowest selling price of the mug the mug receiving students quote was consistently and significantly higher than the quote from the students who did not receive a mug the endowment effect and marketingmany companies strive to exploit the endowment effect for their benefit for instance they may devise strategies that attract customers then leverage the endowment effect knowing it will be difficult for a consumer to leave for example consider how companies can offer free trials to consumers to try their products when people try a product they may become attached to it and see it as something they own making them more likely to purchase it this same emotion may be felt during limited time offers where consumers are faced with a sense of urgency to buy a product then forge a relationship with that good companies often personalize products or services to make consumers feel a sense of ownership over them this is done to enhance a sense of ownership and attachment this same attachment can be felt through loyalty programs that offer rewards or incentives for repeat purchases last companies often leverage social media to substantiate and prove how other users are attached to their products those that see this messaging may resonate with how other people are emotionally attached to goods and further enhance their own relationships consider whether or not you would buy something you already own if you wouldn t but aren t willing to sell the item perhaps you overvalue something you currently own 