The Endowment Effect as a Blessing
No 5862, Working Paper from Department of Economics, University of Pittsburgh
We study the idea that seemingly unrelated behavioral biases can coevolve if theyjointly compensate for the errors that any one of them would give rise to in isolation.We pay specific attention to barter trade of the kind that was common in prehistoricsocieties, and suggest that the â€œendowment effectâ€ and the â€œwinnerâ€™s curseâ€ couldhave jointly survived natural selection together. We first study a barter game witha standard payoff-monotone selection dynamic, and show that in the long run thepopulation consists of biased individuals with two opposed biases that perfectly offseteach other. In this population, all individuals play the barter game as if they wererational. Next we develop a new family of â€œhybrid-replicatorâ€ dynamics. We showthat under such dynamics, biases are stable in the long run even if they only partiallycompensate for each other and despite the fact that the rational typeâ€™s payoff is strictlylarger than the payoffs of all other types.
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