Consider this. You buy a lottery ticket knowing the odds of winning. You nevertheless eagerly wait for the draw. So, how would you feel when you find that you did not win the lottery? If you are typical person, you are likely to have an emotional reaction. Why is that so?

It is true that the odds of winning are low. But you know that someone could win the draw. And that someone could be you! Most of us, hence, visualise what we would do if we win the lottery.

Often, this involves buying aspiration assets. These are assets that we cannot afford to buy today given our current level of wealth.

Such visualisation leads to emotional attachment to the fantasy. And such fantasy, in turn, leads to what behavioural psychologists call the endowment effect.

Endowment effect

The endowment effect refers to our tendency to demand more to give up an object that we possess than we would pay to acquire the same object! Suppose you possess a pen that the late Sir Donald Bradman used to sign autographs.

The endowment effect states that the money you would demand to give up the pen will be much more than the money you would be willing to pay for the pen, if you did not have it already.

Sometimes, the endowment effect can prompt you to take more risks. How? The failure to win the lottery shatters your fantasy, leading to an emotional reaction. And such reaction could prompt you to buy more lottery tickets (risking more capital) in the hope of winning the draw the next time!

Such behaviour can have far-reaching implications. Suppose you bought a stock at Rs 465 and that the current market price is Rs 485.

The endowment effect means that you would be willing to give up the shares only if you get a price higher than Rs 485. And if the price declines without filling your sell-order, you continue to hold your position… even if they eventually end-up in losses!

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