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Swapping & Prospect Theory

29/4/2015

 
By David Butler

Just under a year ago I spoke about children trading soccer stickers in the
playground. This struck a chord with some students and since then I've been asked about collecting and swapping stickers – I think it’s the case that just like playing sport, nearly everyone has experience being a  collector of some sort.  The Economist newspaper recently put the Economics of the Playground more persuasively than I could, when they said that, “for evidence that the inclination to barter and truck is in our genes, one need venture no farther than the nearest schoolyard. Lurking within school walls is a thriving economy...”

Rather than just chatting about these ideas and the fun of collecting, I try to teach my students some Behavioural Economics too. I usually advise them to check out John List’s now quite famous 2003 and 2004 papers -
Does Market Experience Eliminate Market Anomalies? and Neoclassical Theory versus Prospect Theory: Evidence from the Marketplace.

List, who is well known in economics for carrying out cool field experiments, connected the idea of sports card trading with concepts from Behavioural Economics by going on the road and visiting a trade show.  His intention was to explore the idea of Reference Dependence and test for the Endowment Effect.  This is the tendency for people to place a higher value on goods they own. The key question of these studies was whether this Endowment Effect, that shows up in the laboratory, existed in the field or ‘real world’ - was it the case that people were just loss averse in the lab, but that this behaviour would wash in the marketplace?

At the trade show List got two groups of participants, all of whom naturally had different experience levels trading sports cards. He randomly assigned sports memorabilia to both groups for filling in a questionnaire. In this form participants were asked how much practice they had trading cards – if you traded more than 6 times a month you were considered experienced. The first group got a ticket stub for the Kansas City Royals and the second group got a commemorative cert for the Milwaukee Beavers. List must have deemed these to be of equal value to sports enthusiasts. Participants were then offered the opportunity to trade. Standard economic theory would predict that 50% of the memorabilia would be traded.

The results were interesting – participants who didn't have much trading experience traded very little (only 6.8% of the time).  List compared these results to the predictions of the standard economic model and suggested that it was evidence of the Endowment Effect in a natural setting. What about those participants that were considered experienced?  These participants traded a lot more (46.7% of the time). This was not down to the indifference of inexperienced subjects. As a separate experiment showed, this group also wanted a lot more money to give up their endowed memorabilia than the experienced group.

But there was a causality issue however - was it the case that experience was causing participants not to exhibit the Endowment Effect or was it that people who lack the Endowment Effect are more likely to trade? Also, maybe novices where just scared of being ripped off?  List had to control for experience over time. To do this he returned to the trade show a year later and actually managed to catch up with many of the same participants. Again, he asked them how much they traded. Curiously, he found that as traders got more experienced the Endowment Effect decreased, supporting the idea that experience made traders savvier and that the market can wash out this effect. In his later 2004 paper, List showed that this trading experience can actually spill over as collectors that are more experienced in card trading are also less likely to exhibit the Endowment Effect when it comes to other goods.   

While not doubting that adults and children think differently, maybe if we want school kids to be savvy in the market place it’s a good idea to give them lots of time to swap and trade.The playground definitely offers children an early place to engage in exchange where some shadow pricing system usually exists. Maybe kids might learn more economics at lunch time than in class and perhaps become a little bit more rational along the way too!

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