December 06, 2005
Throwing the Endowment Effect Under the Bus
Posted by Matt Bodie

Charles Plott, the Edward S. Harkness professor of economics and political science at Caltech, and Kathy Zeiler, associate professor at Georgetown Law, published a paper in the American Economic Review about the endowment effect.  A copy of the paper is available here; another Plott-Zeiler paper on prospect theory, presented at last May's ALEA conference, is here.  The authors make a persuasive case that there was less to the endowment effect than earlier studies had indicated.  In brief, the endowment effect is an observed psychlogical phenomenon where folks value something that they have more than they would value the exact same thing if they didn't have it.  (You may have heard of the famous mugs experiments.)  In their paper, Plott and Zeiler argue than basic manipulation of the experimental procedures minimizes or even eliminates the endowment effect. 

Josh Wright and Todd Zywicki have recently blogged about the paper and its ramifications.  (Zywicki initially blogged about the paper here, with a good explanation of some of the terms used.)  Wright notes that in the past three years 189 law review articles have discussed the endowment effect, and he surmises that they have generally been making the same, anti-Coasean argument.  In his last graf, Wright argues:

Prior to reading Plott & Zeiler, I was fairly confident that the number of "endowment effect" regulatory proposals meeting [a rigorous proof] standard was small, and possibly zero.  Pending convincing contradictory evidence that the effect actually exists in markets, the set of qualifying proposals now appears to be null.  My only question is: What would the law reviews do with all that extra space?

Zywicki is a little more restrained -- he states, "Like Josh, I am curious to see what effect, if any, the Plott and Zeiler paper has on the production and publication of law review articles based on the endowment effect."

I guess I would like to just add a note of caution before we decide that the endowment effect no longer exists, or can no longer be written about in law reviews.  Law profs are often criticized for jumping to conclusions based on a thin reading of social science data.  As social scientists will often note, one study is not enough to scrap an old theory or create a brand new one.  Only testing and retesting, over time and by different researchers, get us closer to the truth.

So I fear that Wright may be doing what he criticizes -- namely, jumping to a conclusion based on preliminary social science findings.  Yes, I agree the Plott-Zeiler paper calls for further research into what, if anything, creates the endowment effect, and how robust the effect remains if subjected to various influences.  But should we say that years of research demonstrating a theory proposed by a Nobel prize winner are meaningless, thanks to one article?  If so, the Coase theorem itself wouldn't have lasted that long, either.

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