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People who exhibit endowment bias value an asset more when they own it, as compared to when they don’t. This is inconsistent with standard economic theory, which asserts that a person’s willingness to pay for a good should always equal the person’s willingness to accept disposition of the good.
In essence, this bias is a mental process in which a differential weight is placed on the value of an object. That value depends on whether one possesses the object and is faced with its loss or whether one does not possess the object and has the potential to gain it.
If one loses an object that is part of one’s endowment (ownership), then the magnitude of this loss is perceived to be greater than the magnitude of the corresponding gain if the object is newly added to one’s endowment.
For example, this bias influences traders to hold onto losing positions because they feel that they “own” the position, and are reluctant to close it and enter a better position instead, although the potential gains are higher. This is often the result of decision paralysis, which places an irrational premium on the compensation price demanded in exchange for the disposal of the endowed asset.
What is the best solution for this?
One way to break free from flawed thinking is to ask yourself, “if you did not have any positions at the moment, would you still choose to take the same position which you are currently holding?” If you answered no, then you might want to reflect on why you are still holding onto it.
“A wise man should have money in his head, but not his heart.”
– Jonathan Swift
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Spencer is an avid globetrotter who achieved financial freedom in his 20s, while trading & teaching across 70+ countries. As a former professional trader in private equity and proprietary funds, he has over 15 years of market experience, and has been featured on more than 20 occasions in the media.