Behavioral Bias Bingo: Trophy Effect

////Behavioral Bias Bingo: Trophy Effect

Behavioral Bias Bingo: Trophy Effect

By | 2017-08-18T17:09:34+00:00 June 17th, 2014|Behavioral Finance|0 Comments

Hard work ≠ Value

“Imagine you play in a tennis tournament at your local club. As your opponents are of the same strength as you, playing the matches is hard work. Now imagine you have managed to win the tournament and the prize is a trophy which is sold for 5 € at a local shop. For how much are you willing to sell this trophy? How much might your opponents be willing to pay for this trophy? “

— Christoph Buhren, Marco Pleβner, (2011).

While it may be just a trophy, it may represent much more to you if you went out on the court, sweated and worked hard to “earn” it.

How much?

Well certainly more than  the 5 € you would pay at a store, right? After all, they aren’t handing these trophies out to just anyone.

Conversely, if you went out on the court, sweated and worked hard, but didn’t win the trophy, well then maybe it really is just a trophy after all. If they’re just handing out these trophies willy nilly — basically giving them away — well maybe this trophy worth something less than the 5 € you would pay for it at the store.

It would seem that a form of egotism affects how we value the trophy.

This phenomenon — placing a higher intrinsic value on something when we have worked to earn it — exists in our daily lives, and Buhren and Pleβner prepared a research paper (a copy is here) exploring it in 2011, naming it the “trophy effect”.

Game: Math-test winners can get ball-point pen!

Baseline: In the baseline case, students were given ball-point pens. Some students were told they already owned the pen in front of them and asked what they would sell it for. Other students were told the pen in front of them was offered for sale, and they should specify what they would be willing to pay.

Students who already “owned” the pen were willing to sell it for 2.86 €, while those who did not “own” the pens already but were asked what they would pay responded with a price of 1.00 € .

In this example, we see the “endowment” effect, which describes how we place a higher value on something if we already own it.

Trophy: In the trophy case, students had to complete an elementary mathematics test within 15 minutes. It was brought to their attention that only the best students would be rewarded with a pen afterwards. Those top students, who were rewarded with a pen became “sellers,” while the others, who had not won a pen, became “buyers.”

The results of the experiment, designed by Buhren and Pleβner and discussed in the paper, were surprising.

This time, the “winners,” consisting of those students who had passed the math test to “win” the trophy wanted a lot more, demanding 4.40 € for each pen.

For the “losers,” or those who did not pass the mat test, they decided they would only pay 0.50 € for the pen.

Note that the trophy effect worked both ways, by raising and reducing the pen’s value based on the outcome of the math test — those who worked for the pen wanted more (4.40 €) than when it was simply given to them (2.86 €), and those who failed to win the pen placed even less value on it (0.50 €) than when it was just a pen to be evaluated (1.00 €) in the baseline case.

Applications in Finance:

We have seen, in the examples above, how when we work hard for something, thereby “earning” it, we can ascribe a higher value to it than may be justified. This may hold in financial markets.

Let’s say you own two stocks, Stock A and Stock B, and you need to raise some cash, and must decide which one to sell.

You have worked for many years at Company A, and as a result of your hard work you have earned a large amount of Stock A.

A rich uncle of yours died a few years ago, and in his will gifted you a large block of Stock B.

Which do you sell to raise the cash?

Reference:

Christoph Buhren, Marco Pleβner, (2011), The Trophy Effect, Joint Discussion Paper Series in Economics, ISSN 1867-3678


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About the Author:

David Foulke
David Foulke is an operations manager at Tradingfront, Inc., a provider of automated digital wealth management solutions. Previously, he was at Alpha Architect, where he focused on business development, firm operations, and blogging on quantitative investing and finance topics. Prior to Alpha Architect, he was involved in investing and strategy at Pardee Resources Company, a manager of natural resource and renewable assets. Prior to Pardee, he worked in investment banking and capital markets roles at several firms in the financial services industry, including Houlihan Lokey, GE Capital and Burnham Financial. He also founded two internet companies, E-lingo, and Stonelocator. Mr. Foulke received an M.B.A. from The Wharton School of the University of Pennsylvania, and an A.B. from Dartmouth College.

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