Abstract:
We establish a theoretical link between three phenomena at the core of behavioral economics: the Endowment Effect, Loss Aversion, and violations of Expected Utility as in the Certainty Effect. In our model, all jointly stem from one single force: uncertainty about the utility function to use and caution. Behaviorally, we show that our model is derived from positing a form of the certainty effect, that we show implies both Loss Aversion and the Endowment Effect. We analyze further implications of our model and demonstrate how it can organize existing empirical evidence of the Endowment Effect, and how it is conceptually and behaviorally distinct from other popular approaches, e.g., Cumulative Prospect Theory.