Identifying Blindspots: Endowment Effect
No one makes a mistake knowingly. All the mistakes are made because of things in our blind spot.
Cognitive biases are those blind spots.
The endowment effect is a kind of cognitive bias when we assign a higher value to things we own.
People who select a number in a lottery think the probability of the number selected by them is higher. We know statistically that the probability of selecting any number in a lottery is the same.
This happens all the time in the stock market. People, after buying a stock, defend the story of the stock even when it’s not performing well. They hold onto a losing stock because of the endowment effect.
There are two main psychological tendencies responsible for this:
Loss Aversion and Ownership Bias.
Loss Aversion Bias
Winning $100 is not the same as losing $100. Losing money seems more significant than winning the same amount.
A good example of this can be seen in the stock market. People don’t sell a losing stock as the loss seems too painful.
Ownership Bias
As a famous saying goes — a bird in the hand is better than two in the bush.
We try to give more value to things that we own. We don’t want to break the status quo and keep owning it.
Let’s see how salesman use the endowment effect to their advantage.
When you go to buy a car, the salesman usually lets you test drive it first.
In the test drive, we get a feeling of owning the car and usually assign a higher value because of the emotion.
There are many more examples where people change behavior due to the endowment effect.
I would love to hear about your experience with this.
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