Thursday, November 1, 2012

Mortgage Refinancing

Suppose the reason you're wandering in the desert is that you're on the way home from buying an engagement ring for your sweetie with the cash you got as an unexpected bonus you won from a raffle you forgot you entered, and you took a wrong turn. Instead of a thousand dollars in your pocket, you've got a diamond ring you just paid a thousand dollars for. Jorge is willing to accept the ring for a bottle of water.

Suppose instead that you're lost in the desert with totally empty pockets, but you just happen to find a diamond engagement ring lying in the sand. Being the expert appraiser you are, you correctly estimate the value of the ring at $1000. Again, Jorge wheels on by and is willing to take the ring in trade for a liter of water.

Are these scenarios different? If so, why? Which one is closer to euvoluntary? Kahneman and Tversky did quite a bit of very good work describing the endowment effect, where the simple act of possessing a thing increases its relative value to the holder. The Bird in the Hand theory, if you will. How about emotional freight? In the first circumstance, the ring carries with it special significance, but is that significance relevant to third parties?

I ask because I'm still puzzling over contaminated charity and to a lesser extent, commercial transactions. If I raise money for breast cancer research by holding a wet t-shirt contest, should I be surprised if the recipient turns it down? Can the Sierra Club accept donations from known polluters in good conscience? How about going into hock? All else equal, is there any moral difference between on the one hand pawning a ring from a broken engagement and on the other hand one handed down from grandma?

And what of the use of the proceeds? The reason the kid in China who sold his kidney to buy an iPad made international news was that his purchase was pretty widely regarded as frivolous. If he'd have done it to make a mortgage payment or two for the family home, I don't think there would have been as much outrage. I think I've made a case here for regret aversion by proxy as being a reasonable source of much paternalistic sentiment, but what other proxy sentiments might have bite? Prudence? Propriety? Dignity? Cleanliness? How much of this sentiment rules beliefs over the first two conditions of EE: conventional ownership and conventional capacity to exchange?

Also, forgive the misleading title. I'm interested to see if I get more spam comments from bots. Consider it a test of sorts.


  1. I believe there is a difference between your two scenarios which makes the second closer to euvoluntary, but it is a technical reason that doesn't change your point. I think you're ignoring consumer surplus in the first scenario. You purchase the ring for $1000, but you probably value it more than that. Your willingness to pay would only through extreme coincidence been exactly equal to the price. You could correct this simply by saying, "Instead of a thousand dollars in your pocket, you've got a ring that you value personally, subjectively at a thousand dollars."

    1. Agreed, and that's the very point I think is completely relevant for third-party considerations. Consumer surplus is, by its nature, entirely inscrutable to outside parties. This implies severe knowledge constraints on third parties, especially under thin market or non-ergodic conditions.

      But yes, you picked up on my point perfectly and you stated it more succinctly. I'm glad to see I have readers who won't let me get away with a sneaky end-run.

  2. As far as I have heard refinancing mortgage is not really the best option you should be considering. The process is really long and tiring ( a lot of people are ready to overpay to get the faster service, some even to apply for
    fast pay day advance in order to afford this faster and what is more important individul service). Don't get caught by tempting pomotions they have. Be sure to read every single detail before you decide to stick with it and put your signature on papers

  3. refinancing may not make sense if (1)you've had your current mortgage for a long period of time. (2)you've paid off most or all of the interest on your current mortgage. (3)Your existing mortgage contains a prepayment penalty clause.


Do you have suggestions on where we could find more examples of this phenomenon?