On the Endowment Effect

“There is a very real difference,” my friend told me, “between getting a car ‘new’ and getting it ‘second-hand’. When you’re getting it second-hand, you have no idea what the previous owner did with (or in) the car.”

He should know. We were sitting in his (second-hand) car, bought just a couple of months back, his sixth car in three years. Of these six, only his first two were new.

It reminded me of something I’d been thinking about lately: the endowment effect, of which definition I’ve happily copied and pasted below from good ol’ Wikipedia:

The endowment effect (also known as divestiture aversion) is the hypothesis that people ascribe more value to things merely because they own them. This is illustrated by the observation that people will tend to pay more to retain something they own than to obtain something owned by someone else—even when there is no cause for attachment, or even if the item was only obtained minutes ago.

There have been a number of experiments done to demonstrate this effect, with the one that I’ve read about the most times being the following (also from Wikipedia):

One of the most famous examples of the endowment effect in the literature is from a study by Kahneman, Knetsch & Thaler (1990) where participants were given a mug and then offered the chance to sell it or trade it for an equally priced alternative good (pens). Kahneman et al. (1990) found that participants’ willingness to accept compensation for the mug (once their ownership of the mug had been established) was approximately twice as high as their willingness to pay for it.

But I’ve never actually read about an experiment that tried to explain it in terms of the bid/ask spread as it relates to investing (which compensates for risk) and information asymmetry. Or how it relates to how our default option is really not to trade, and that trading requires motivation and commands a premium.

For example, let’s say you are given the choice to buy the mug. There’s no reason to think that the amount quoted to you would be below the market price.

On the other hand, if you are given the mug, and then someone quotes you a price for it, there’s no reason to think that it would be above the market price, even if that price came in the form of a set of equally priced pens.

In fact, try playing the scenario in your head and see if you’d do any different:

  1. The experimenter (a stranger) comes up to you and says, “would you like a mug or a pen? By the way, both cost the same.”
  2. Randomly, you choose the mug. There is no reason, at this point in time, to think either the mug or the pen costs more than the other.
  3. The experimenter gives you the mug.
  4. After five minutes, the same experimenter comes up to you and offers you the choice to trade, saying, “are you sure you don’t want to have this set of pens instead of the mug? I’m willing to trade if you are…” (these are the same pens talked about in point #1)
  5. What would you think? Personally, I’d think there was a catch. You give me a mug, and five minutes later you’re trying to get it back. It’s got to be worth more than the pens if not why on earth would you want to trade?

Point #5 highlights risk and information asymmetry. There’s a risk I’m getting the shorter end of the stick because the experimenter seems to know more than me (i.e. the “true” value of the mug and pens). Why else would s/he offer to trade? (This, I think, is why new cars command such a premium over pre-owned ones. There’s a big risk pre-owned cars were subject to abuse you’d prefer not to know about. Why else would the car owner want to sell?)

Experiencing this risk would urge me to ask for more. If you give me $X more than you’re offering, I’m willing to take the risk that the mug really isn’t worth more than you say it is worth. If I decided on the trade, it’d mean that I trusted you completely on the fact that they were worth the same.

And let’s not forget the idea that people in general don’t really like to think; we don’t like to expend energy unnecessarily. If there’s a risk that we could be losing out, but we don’t really want to think about it, the default option would be to just say “no”, or quote a price such that it’s easy to say “yes”.

The World as it Should Be

Just thought I would share with you what has to be, for me, the quote of the week. Taken from the book Getting More, a beautiful book on negotiation by Stuart Diamond (emphasis mine):

Lower your expectations. If you come into a negotiation thinking that the other side will be difficult, unfair, rude, or trying to cheat you, you won’t be likely to have dashed expectations–and you won’t be emotional. When you lower your expectations of what will take place in a negotiation, you will be rarely disappointed–and you might be pleasantly surprised. Getting yourself psychologically prepared is important.

You might feel, “Hey, I shouldn’t have to do things like that.” Okay, maybe not. But we live in the real world, not in the “should” world.

The beauty of that statement, I think, lies in the fact that it embraces the irrationality of people, the irrationality of the world. Where things are done sometimes for reasons beyond human comprehension.

And even if you don’t believe in the irrationality of people, as I sometimes find myself wont to do, the fact is we as human beings have so many hidden motivations that though we are, perhaps, ultimately rational, we are for most practical purposes just the opposite.

Back to writing

It’s been such a long time since I last wrote anything here (blame the whole ____load of work that’s been coming in; hint: sounds like “ship”) that I’m suddenly all self-conscious about it.

It reminds me of a period of my life where I used to wear running shorts all the time. I wore them in camp (i.e. army camp — I was serving national service at that time); at home; occasionally when I sent out for short food trips; and, of course, for runs.

Then for some reason I stopped. For four months.

Then I tried them again.

“Wow, your pants are sexy,” exclaimed my dad, unused to how I looked in them having not been in them for so long.

It’s been almost ten years since.

Since that statement.

Since I last wore my sexy short running shorts.

I suppose though, that there is one difference between my writing after a long absence and my wearing running shorts.

If someone said my words were sexy, it’d probably be 10 seconds before I wrote my next.

Roy Ngerng, CPF, and the Widow who Lost $1m

Current affairs currently in my head, in a nutshell:

  • Roy Ngerng criticises Singapore’s CPF, likens it to schemes of questionable legality.
  • Singapore Prime Minister Lee Hsien Loong sues him for defamation. Many citizens think this is a bad move. See also: Catherine Lim’s open letter
  • Among criticisms, Ngerng says government should make it easier for citizens to withdraw their CPF, and/or more of it (e.g. by lowering  the “minimum sum”, which is what can’t be touched/withdrawn).
  • Apparently quite a number of people agree: Citizens should be trusted with their money.

On this last point, as intuitive as it is, and as much as I wish that was true, it probably isn’t.

Last weekend, I read a story that provided a great example of how difficult it is to trust ourselves with money:

Two years ago, after her husband was killed in a freak accident while working at Changi Airport’s Budget Terminal, she received nearly $1 million in insurance payouts and donations from the public.

Today, that money is all gone.

Madam Pusparani Mohan, 34, is now looking for work in Singapore to support her four young children back in Johor Baru.

“I made a mistake. People knew I had so much money and they all came to me. I am so stupid. I never buy house and finished all the money meant for my children,” Madam Pusparani told The Sunday Times from her home in Skudai.

It is funny how the people who most need to withdraw CPF monies are the very same people who most need their CPF monies kept from them.

It is easy to say: give me my CPF, and let me invest it; I can do infinitely better than the infinitesimal 2.5% the government gives me.

But how many people in reality can do it? I know of people who jump through hoops just to get 3% interest on their savings. 2.5% really isn’t that bad.

But for the sake of argument, let’s say most people can get that 2.5% or more. In fact, let’s quantify that and say that 70%  of the population can (and how unlikely this is! Imagine that for every 10 people you walk past on the street who are old enough to possibly withdraw their CPF, seven are able to get a return 50 or more times the existing savings rate of 0.05%).

This leaves us with the 30% who can’t manage their money. Who’s responsibility is it to help them? Let’s say these people finish spending their CPF monies within 5 years (that’s 3 years longer than Madam Pusparani Mohan mentioned in the story above).

What then? Should the 70% who do earn more be taxed on their earnings to pay for 30%? Would the tax be enough to cover the loss?

Maybe. But probably not.

Though those of us who probably can manage our money pretty well would love to have our CPF in our hands and not the government’s, we’re probably the ones who least need our CPF in the first place.

Donn & Li Shya Marriage

Why you will fail to have a great career

This is a beautiful talk, one that addresses something I’d felt strongly about since I started thinking seriously about my professional life back when I was studying at Temasek Polytechnic.

I remember sitting in the lecture hall, listening to an entrepreneur who had been invited to speak to us business students. During the Q&A, I couldn’t help but ask if his business success had come at the price of family.

I can’t quite recall what he said, but I suspect it had something to do with it not being quite the answer I had hoped: “no”.

It’s been more than a decade on. Having been through two years of National Service, another two overseas at UWA (University of Western Australia), marriage, and five years of relatively productive work, my question remains. Still unanswered.

But this time, the perspective’s a little different. I’m asking it from the inside. I’m living the answer, writing it as I go along. So far so good, but I think I’ve got a little bit more capacity for that weirdness; that abnormification; that passion to burst onto the scene.

So when my child questions why I haven’t lived my dream, I won’t have to say, “because of you.”

The place for the polymath. Because there's too many good things in life to be great at just one thing.