Controlling for the Compromise Effect Debiases Estimates of Risk Preference Parameters

121 Pages Posted: 5 Dec 2015 Last revised: 20 Oct 2020

See all articles by Jonathan Beauchamp

Jonathan Beauchamp

University of Toronto

Daniel J. Benjamin

Anderson School of Management; USC, Center for Economic and Social Research (CESR); National Bureau of Economic Research (NBER); Human Genetics Department, David Geffen School of Medicine

David Laibson

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Christopher F. Chabris

Harvard University - Department of Psychology

Multiple version iconThere are 2 versions of this paper

Date Written: August 20, 2018

Abstract

The compromise effect arises when options near the "middle" of a choice set are more appealing. The compromise effect poses conceptual and practical problems for economic research: by influencing choices, it distorts revealed preferences, biasing researchers' inferences about deep (i.e., domain general) preferences. We propose and estimate an econometric model that disentangles and identifies both deep preferences and the context-dependent compromise effect. We demonstrate our method using data from an experiment with 550 participants who made choices over lotteries from multiple price lists. Following prior work, we manipulate the compromise effect by varying the middle options of each multiple price list and then estimate risk preferences without modelling the compromise effect. These naïve parameter estimates are not robust: they change as the compromise effect is manipulated. To eliminate this bias, we incorporate the compromise effect directly into our econometric model. We show that this method generates robust estimates of risk preference parameters that are no longer sensitive to compromise-effect manipulations. This method can be applied to other settings that exhibit the compromise effect.

Keywords: compromise effect, cumulative prospect theory, loss aversion, risk preferences

JEL Classification: B49, D03, D14, D83, G11

Suggested Citation

Beauchamp, Jonathan and Benjamin, Daniel J. and Laibson, David I. and Chabris, Christopher F., Controlling for the Compromise Effect Debiases Estimates of Risk Preference Parameters (August 20, 2018). Available at SSRN: https://ssrn.com/abstract=2698922 or http://dx.doi.org/10.2139/ssrn.2698922

Jonathan Beauchamp (Contact Author)

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Christopher F. Chabris

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