Chapter 4 Analysis of Cognitive Bias in Allowances Trading
B. Verification of status quo bias and preference for over-retention
Of 131 collected surveys, 130 were used to verify status quo bias and preference for over-retention after stripping out 1 survey with no answers. The characteristics of these 130 samples are shown in Table 4-4. Hypothesis 2-1 assumes that the rate of opting to retain more allowances than emissions through decision-making on a transaction in a situation of surplus allowances may be higher than the rate in a situation of a shortage of allowances. Basically, this hypothesis assumes that the status quo (surplus allowances vs. a shortage of allowances) causes different choices regarding a future situation. Accordingly, this study will seek to verify hypothesis 2-1 by determining whether different choices are made regarding a future situation according to the status quo and whether the rate of opting to retain more allowances than emissions through decision-making on a transaction in a situation of surplus allowances is higher than the rate in a situation of a shortage of allowances.
Table 4-4. Characteristics of Samples Used to Verify Status Quo Bias and Preference for Over-retention General situation
(general public)
Consignment auction situation (general public)
General situation
(workers directly involved in allowances trading)
Surplus allowances
Shortage of allowances
Surplus allowances
Shortage of allowances
Surplus allowances
Shortage of allowances
# of
responses
35 (20 male, 15 female)
33 (19 male, 14 female)
27 (13 male, 14 female)
35 (20 male, 15 female)
37 (n.a.)
45 (n.a.) Average
age
23.3 (Min 21, Max 27)
23.4 (Min 20, Max 28)
23.4 (Min 20, Max 30)
23.5 (Min 20, Max 26)
n.a. n.a.
As indicated in Table 4-5, the selection rate of over-retention was higher in a situation of surplus allowances in the surveys of the general public and workers directly involved in allowances trading in a general situation. On the other hand, the selection rate of over-retention was lower in a situation of surplus allowances in the survey of the general public in a consignment auction situation (59.3% vs. 60.0%). Thus, it was concluded that status quo bias did not occur in the survey of the general public in a consignment auction situation. The chi-square test of independence ( ) was conducted to determine if the selection rate of over-retention would be different in a situation of surplus allowances on the one hand and a shortage of allowances on the other. The difference turned out to be insignificant in the survey of the general public in a general situation (Pearson =1.427, p=.232), but
significant in the survey of workers directly involved in allowances trading (Pearson =40.982, p=.000). To sum up, hypothesis 2-1 was partially supported: it was dismissed for the general public but supported for workers directly involved in allowances trading.
Table 4-5. Statistical Verification of Status Quo Bias
Meanwhile, hypothesis 2-2 predicted that status quo bias would decrease among workers directly involved in allowances trading. However, according to the above analysis, status quo bias occurred only among such workers.
Accordingly, verification was not attempted in this study in relation to hypothesis 2-2, and that hypothesis was dismissed. Hypothesis 2-3 presumed that consignment auctions would reduce status quo bias. According to the surveys of the general public in a general situation and a consignment auction situation, status quo bias did not occur in either situation. Thus, hypothesis 2-3 was not supported.
Now, the preference for over-retention covered in hypothesis 3-1 will be examined. According to Table 4-6>, workers directly involved in allowances trading who answered the survey preferred over-retention in a situation of surplus allowances. Analysis showed a stronger status quo bias among such workers. Their selection rate of over-retention in a situation of an allowance shortage stood at less than 50%, reflecting the effect of status quo bias.
Table 4-6. Statistical Verification of Preference for Over-retention
Accordingly, in order to verify preference for over-retention, it is necessary to exclude the effect of status quo (surplus allowances vs. shortage of allowances). As such, the accuracy of hypothesis 3-1 will be verified by
General situation (general public)
Consignment auction situation
(general public)
General situation
(workers directly involved in allowances trading) Surplus
allowances
Shortage of allowances
Surplus allowances
Shortage of allowances
Surplus allowances
Shortage of allowances
# of those selecting over- retention
(selection rate) 25 (71.4%)
19 (57.6%)
16 (59.3%)
21 (60.0%)
37 (100.0%)
14 (31.1%)
Test of
independence for status quo bias
Pearson =1.427, p=.232
Pearson =.003, p=.953
Pearson =40.982, p=.000**
General situation (general public)
Consignment auction situation
(general public)
General situation
(workers directly involved in allowances trading) Surplus
allowances
Shortage of allowances
Surplus allowances
Shortage of allowances
Surplus allowances
Shortage of allowances
# of those selecting over- retention
(selection rate) 25 (71.4%)
19 (57.6%)
16 (59.3%)
21 (60.0%)
37 (100.0%)
14 (31.1%)
44 (64.7%) 37 (59.7%) 51 (62.2%)
Binomial test of preference for over-retention
p=.021* p=.162 p=.035*
Test of independence for preference for over-retention
General situation: general public vs. workers directly involved in allowances trading =.101, p=.751
General public: general situation vs. consignment auction =.349, p=.555
combining answers from a situation of surplus allowances and that of a shortage of allowances to see if the selection rate of over-retention exceeds 50%. In this case, the number of surplus allowance samples and of allowance shortage samples may influence the result, but the impact of this is not expected to be significant. A binomial test was conducted to determine if the selection rate of over-retention exceeded 50% in each situation.
For the general public, the selection rate of over-retention exceeded 50% in a general situation (observation ratio
=.647, p=.021) but did not exceed 50% in a consignment auction situation (observation ratio =.597, p=.162). For workers directly involved in allowances trading, the selection rate of over-retention exceeded 50% (observation ratio
=.622, p=.035). Consequently, the preference for over-retention proved significant for the general public in a general situation and workers directly involved in allowances trading.
Meanwhile, hypothesis 3-2 assumes that workers directly involved in allowances trading have less preference for over-retention than the general public. The chi-square test of independence ( ) was conducted using the survey result of the general public in a general situation and the survey results of workers directly involved in allowances trading to verify hypothesis 3-2. The result showed that the selection rate of over-retention was not significantly different between the general public and workers directly involved in allowances trading (Pearson
=.101, p=.751). Accordingly, hypothesis 3-2 was dismissed. Meanwhile, to determine if preference for over- retention is weaker in a consignment auction situation compared to in a general situation (not hypothesized), the chi-square test of independence ( ) was conducted to compare the general public in both situations. It was found that preference for over-retention was not weaker in a consignment auction situation (Pearson =.349, p=.555).
5. Sub-conclusion
This study sought to verify whether the three cognitive biases of the endowment effect, status quo bias, and preference for over-retention occur in allowances trading. As a majority of countries are working to vitalize such trading, which is reported as lackluster in Korea, the authors of this study believe efforts to explain the reasons behind sluggish allowances trading have a significant meaning for policy-making to increase such trade.
According to the tests conducted by this study, the endowment effect was found in all three cases (general public in a general situation/consignment auction situation, and workers directly involved in allowances trading in a general situation) while status quo bias was identified only among workers directly involved in allowances trading.
Lastly, preference for over-retention was found among the general public in a general situation and among workers directly involved in allowances trading. All in all, this demonstrates that cognitive bias contributes to sluggish trading.
This study also verified whether preference for over-retention not regarded as a cognitive bias occurs, and explained its mechanism. The authors believe this will be an important contribution. Existing studies presume that preference for over-retention is caused by overall market forecasts of a shortage of allowances or an organization’s incentive system. However, the tests in this study were based on independent scenarios separate from market forecasts or incentive systems. When explaining a preference for over-retention based on the logic of behavioral economics, the Prospect Theory may explain the tendency not to engage in a transaction (selling) in a situation of surplus allowances, but cannot explain the tendency to engage in a transaction (buying) in a situation of a shortage of allowances. On the other hand, from the perspective of mental accounting, it can be inferred that surplus allowances would be preferred in both scenarios. Consequently, preference for over-retention can be seen as a tendency to minimize possible loss in the future and feel a sense of gain according to mental accounting. This also relates to the Regret Aversion mentioned by Kahneman, etc. (1991).
In addition, this study sought to verify whether workers directly involved (and with experience) in allowances trading show less cognitive bias - such as the endowment effect or preference for over-retention - than the general public. However, the endowment effect was stronger among such workers, while they were the sole group to be significantly affected by status quo bias. All in all, more cognitive bias seems to occur among workers directly involved in allowances trading. To reduce the endowment effect, status quo bias, and other forms of cognitive bias in connection with allowances trading, each organization should understand that cognitive bias may occur and provide education against it for their workers directly involved in allowances trading.
Lastly, this study sought to determine whether consignment auctions already introduced in the US could reduce cognitive biases, through a test methodology. It was found that these existing consignment auctions did not significantly reduce the endowment effect, while status quo bias did not occur, whether consignment auctions
were involved or not. Accordingly, the hypothesis presuming that consignment auctions may reduce the endowment effect and status quo bias was dismissed. This result is meaningful in that the effectiveness of consignment auctions was assessed from the perspective of behavioral economics.
All in all, this study found that the endowment effect and preference for over-retention, which stand in the way of revitalizing allowances trading, do in fact occur in allowances trading. The authors of this study anticipate that these findings will provide a basis for reviewing steps to reduce cognitive bias occurring in the process of such trading.