Trading experience modulates anterior insula to reduce the endowment effect

Abstract

People often demand a greater price when selling goods that they own than they would pay to purchase the same goods-a wellknown economic bias called the endowment effect. The endowment effect has been found to be muted among experienced traders, but little is known about how trading experience reduces the endowment effect. We show that when selling, experienced traders exhibit lower right anterior insula activity, but no differences in nucleus accumbens or orbitofrontal activation, compared with inexperienced traders. Furthermore, insula activation mediates the effect of experience on the endowment effect. Similar results are obtained for inexperienced traders who are incentivized to gain trading experience. This finding indicates that frequent trading likely mitigates the endowment effect indirectly by modifying negative affective responses in the context of selling.training | neuroeconomics | loss aversion | decision-making T he most fundamental assumptions in economics revolve around individual preferences. The most basic of these is the independence assumption: that one's economic valuation does not depend on current entitlements. In a normative sense, this assumption is used in most theoretical and applied economic models to assess the operation of markets. In a positive sense, the assumption underlies benefit-cost analysis, estimates of damages in court, and more generally any interpretation of indifference curves.However, substantial evidence has mounted that illustrates the importance of entitlements: people ask greater prices for goods that they own than they are willing to pay for identical goods that they do not own, a well-known behavioral anomaly called the endowment effect (1). Importantly, behavioral research demonstrates that trading experience reduces the gap between buying and selling prices (2-4). Nevertheless, little is known about the mechanisms that underlie how experience attenuates the endowment effect. Understanding the mechanisms at work will critically shape how we view the observed violations in inexperienced traders: Are such behavioral patterns errors that violate closely held economic theory, or do they have basic explanations that permit us to retain the standard model with necessary adjustments?We focus on two possible reasons that frequent trading reduces the endowment effect. First, trading may decrease loss aversion (5), or relatively greater anticipated pain of losing goods than excitement about gaining goods. For example, experienced traders may learn to change their mindset so that they do not view selling an object as a loss (6). Second, owning an object may enhance the object's attractiveness (7, 8), but experienced traders may learn to valuate goods more consistently.Distinct neuroanatomical circuits are activated during product preference and loss aversion (9). Specifically, the nucleus accumbens (NAcc) and orbitofrontal cortex (OFC) have been related to product preference and predict buying decisions (10-13). In contrast, right anterior insula activation has been impli...

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