Monday, May 13, 2013
Ulric B. and Evelyn L. Bray Seminar
Sunk Cost Fallacy in Driving the World’s Costliest Cars
Teck-Hua Ho, William Halford, Jr. Family Chair in Marketing, Haas School of Business, UC Berkeley
Do decision-makers suffer from the sunk cost fallacy in high-stakes situations? We develop a behavioral model of usage of a durable good with mental accounting for sunk costs. It predicts that the usage increases with the sunk cost, and attenuates with time at a rate that increases with the sunk cost. The model nests conventionally rational behavior as a special case.
We take the model to a panel of 6,474 cars between 2001-2011 in Singapore. During that period, the sunk cost involved in a new car purchase varied substantially with the continuing government policy. We found robust evidence of a sunk cost fallacy. The elasticity of usage with respect to the sunk cost was 0.563(±0.072). An increase in the sunk cost by $4,500 (the outcome of government policy between 2009 and 2010) would have been associated with an increase in monthly usage by 147 kilometers or 8.8%. Our results were robust to various checks including alternative controls for selection, differences in specification, and allowing for heterogeneity in engine size and target cumulative usage.