Friday, August 5, 2016

Trading Experience Mutes The Endowment Effect and Leads To Less Distorted Markets

From Futurity:
Experience in trading may change how the human brain evaluates the sale of goods, muting a well-established economic bias known as the endowment effect.

The findings, published in the Proceedings of the National Academy of Sciences, come from a set of experiments on why traders are less susceptible to the effect—a phenomenon in which people demand a higher price to sell a good than they’re willing to pay for it. Such behavior contradicts standard economic theory, distorting prices and reducing market activity.

Researchers found that while selling, experienced traders had reduced activity in an area of the brain often associated with pain and negative emotions. A separate experiment showed a similar reduction in brain activity after people previously inexperienced in trading were given incentives to trade objects on eBay for two months.

The results suggest such experience reduces the emotional pain tied to selling objects, mitigating the role the endowment effect plays in economic decision-making.

“We were excited to see that our brief intervention can reduce the endowment effect, both in terms of the behavioral response and the brain mechanisms involved. The brain activation patterns of the subjects who were incentivized to trade on eBay began to look very similar to that of experienced traders,” says Ali Horta├žsu, professor in economics at the University of Chicago.

Past research has shown the endowment effect is limited among experienced traders, but little is known about why that happens.

The new study used magnetic resonance imaging to create pictures of the brain. The images demonstrated that specific economic experiences can modify how the brain responds, changing the process people use to make future decisions....MORE
PNAS says the significance of the paper "Trading experience modulates anterior insula to reduce the endowment effect" is:
Trading experience has been shown to reduce the endowment effect, a decision-making bias that distorts market prices and reduces trade. Understanding the mechanisms underlying how experience changes this bias will provide important insights for developing interventions to improve market efficiency. Using functional magnetic resonance imaging, we show that market experience causes a reduction in right anterior insula activation during selling, which mediates a decrease in the endowment effect. These findings suggest that trading mitigates negative affective responses in the context of selling.