The endowment effect and expected utility

Abstract

The endowment effect, which is well documented in the contingent valuation literature, alters people's preferences according to a reference point established in an elicitation question. In particular, the utility that people place on a bundle is both a positive function of the quantities of the goods comprising the bundle, and a negative function of any loss (real or hypothetical) that the elicitation question asks them to incur. Biases such as this have lead some to reject the contingent valuation method as a means of quantifying costs and benefits in favour of other methods of preference elicitation such as standard gambles. But, most preference elicitation methods used by economists require people to express their preferences for one good in terms of their willingness to forego some of another good. Consequently, it is reasonable to expect that, and prudent to check whether, an endowment effect is also evident in other methods of preference elicitation such as von Neumann-Morgenstern's standard gambles. Internal inconsistencies in the standard gamble method from the experimental economics literature and from a study into the value of non-fatal road injuries are shown to be evidence that an endowment effect is also at work in standard gambles.