Endowment effect refers to the reported gaps between willingness to accept and willingness to pay. According to prospect theory, this effect is a result of the underweighting of opportunity costs. Given the high stake involved in a typical housing transaction, endowment effect is expected to have a significant influence on housing decisions. We develop a theoretical framework to study the presence of endowment effect and its role in housing decision-making process. Three hypotheses are derived and tested through a field experiment conducted in Beijing, China. Our empirical results show that endowment effect plays an important role in the formation of judgmental biases in housing decisions. Moreover, endowment effect interacts with housing cycles. Our study highlights the application of prospect theory in the housing market; thus, it not only extends existing theoretical and empirical works in this important sector, but also clarifies consumer behavior in the emerging property market of China.
We thank the editor and two anonymous reviewers for their valuable comments and suggestions on an earlier draft of this paper. We are grateful for the financial support of the National Natural Science Foundation of China (Project #71231005 and #71671076) and the technical support of China Index Academy.
Using prospect theory, we develop a theoretical framework to examine the relationship between leverage and Real Estate Investment Trust (REIT) returns by introducing the concept of reference point. We postulate that firms' capital structure decisions are affected by target leverage (i.e., the reference point) as well as the observed leverage. Market conditions combined with firms' capital structure will put firms in either loss or gain domains, where firms behave differently. In general, the leverage-return relationship is positive in the gain domain and negative in the loss domain. Firms are then subject to asymmetric risk preference in different domains. Our empirical evidence shows strong support for the theoretical model. Compared to the conventional approach where only observed leverage is used, our model is more flexible and realistic in revealing the underlying structure of the leverage-returns relationship.
As opposed to the “low beta low risk” convention, we show that low beta stocks are illiquid and exposed to high liquidity risk. After adjusting for liquidity risk, low beta stocks no longer outperform high beta stocks. Although investors who “bet against beta” earn a significant beta premium under the Fama–French three‐ or five‐factor models, this strategy fails to generate any significant returns when liquidity risk is accounted for. Our work helps understand the beta premium from a new liquidity‐risk perspective, and draws useful implications for both fund and corporate managers.
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