Controlling for the Compromise Effect Debiases Estimates of Risk Preference Parameters

41 Pages Posted: 6 Nov 2016

See all articles by Jonathan Beauchamp

Jonathan Beauchamp

McKinsey Consulting Group

Daniel J. Benjamin

USC, Center for Economic and Social Research (CESR); National Bureau of Economic Research (NBER)

Christopher F. Chabris

Harvard University - Department of Psychology

David Laibson

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

Date Written: October 19, 2016

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 Chabris, Christopher F. and Laibson, David I., Controlling for the Compromise Effect Debiases Estimates of Risk Preference Parameters (October 19, 2016). CESR-Schaeffer Working Paper No. 2016-017. Available at SSRN: https://ssrn.com/abstract=2864665 or http://dx.doi.org/10.2139/ssrn.2864665

Jonathan Beauchamp

McKinsey Consulting Group

Washington, DC
United States

Daniel J. Benjamin (Contact Author)

USC, Center for Economic and Social Research (CESR) ( email )

635 Downey Way
Los Angeles, CA 90089-3332
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Christopher F. Chabris

Harvard University - Department of Psychology ( email )

33 Kirkland Street
Cambridge, MA 02138
United States

HOME PAGE: http://www.wjh.harvard.edu/~cfc

David I. Laibson

Harvard University - Department of Economics ( email )

Littauer Center
Room M-14
Cambridge, MA 02138
United States
617-496-3402 (Phone)
617-495-8570 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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