The endowment effect is a well-known behavioral regularity whereby a person values a good more when he is endowed with it. In their generalization of prospect theory to consumption bundles with multiple attributes, Tversky and Kahneman [1991] imply the endowment effect as a consequence of loss aversion and diminishing sensitivity in gains. It has since frequently been presumed that this form of reference dependent preferences will inhibit trade. However, in this paper it is demonstrated that loss aversion and diminishing sensitivity in gains also imply a dynamic momentum trading effect that increases exchange, so the net effect of such preferences on trading volume is ambiguous. In fact, the momentum effect is shown to completely cancel out the endowment effect in an important class of examples.

We study the classic Gale economy in a series of laboratory markets. Walrasian dynamics predict prices will diverge from an equitable interior equilibrium towards infinity or zero depending only on initial prices. The inequitable equilibria selected by these dynamics give all of the gains from exchange to one side of the market. We argue this economy provides a strong robustness test of previous work demonstrating the predictive and explanatory power of Walrasian dynamics in laboratory markets. Our results show surprisingly strong support for these predictions. In most sessions one side of the market eventually gains more than 20 times the other side through trade, leaving the disadvantaged side to trade for mere pennies. We also find evidence that these dynamics are sticky, resisting exogenous interventions attempting to reverse their trajectories.

We use laboratory experiments to test a consumption-based general equilibrium approach to asset pricing which posits that agents buy and sell assets for the purpose of intertemporally smoothing consumption. These asset pricing models are widely used by macroeconomists and finance researchers but have not yet been subjected to experimental testing. This laboratory approach enables us to induce several fundamental factors which, according to the theory, determine asset prices, such as risk and time preferences, and the process for dividend payments. Preliminary evidence suggests that either intertemporal consumption-smoothing or what can be interpreted as bankruptcy risk in our design (or both) induce stable prices and strongly inhibit the formation of asset price bubbles, a stark departure from most recent asset pricing experiments.