The Hindu Business Line : Endowment effect

One of our friends recently bought shares of Agrotech Foods at Rs 190. He also had several hundreds of them lying in physical form till not so long ago. Our friend sold the shares that he bought recently for small gains. He was willing to sell the ones that he converted from physical form only if the stock moved beyond Rs 300. This did not make economic sense.

If anything, he could generate higher profits from the shares so converted (cost Rs 75 per share), and deploy the money in other stocks identified to fetch him good returns. One explanation for his rather intriguing behaviour could be what behavioural psychologists call as the endowment effect. What is it?

It refers to our behaviour to value goods that we possess at a higher price than if we did not own them. Richard Thaler coined this term after he conducted a study in a class at Cornell University.

Professor Thaler gave half the students in the class coffee mugs and allowed them to trade with the other half who did not receive one. Those possessing the mugs demanded a high minimum price while those without mugs set their maximum price too low.

Premium pricing

In similar experiments that followed, researchers found that we tend to assign a higher value for a good, longer the duration of our ownership. Our demand for premium pricing is also function of whether we have physical possession of the good.

It appears that our friend exhibited this behaviour. He owned Agrotech Foods in the physical form for a longer time that he did the ones in the electronic form.

Besides, you derive more satisfaction when you can touch and feel goods that you own. And when you relate yourself to the good, parting with it becomes that much more difficult.

Perhaps, our friend demanding a higher price for the physical shares was merely a compensation for the sense of loss of the touch-and-feel ownership. Human behaviour drives economics in more ways that we can imagine!

(The author is a Chennai-based investment strategist.)

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