Measuring and controlling for the compromise effect when estimating risk preference parameters
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Measuring and controlling for the compromise effect when estimating risk preference parameters Jonathan P. Beauchamp1 · Daniel J. Benjamin2,3 · David I. Laibson3,4 · Christopher F. Chabris5 Received: 17 April 2017 / Revised: 15 November 2019 / Accepted: 9 December 2019 © Economic Science Association 2019
Abstract The compromise effect arises when being close to the “middle” of a choice set makes an option more appealing. The compromise effect poses conceptual and practical problems for economic research: by influencing choices, it can bias researchers’ inferences about preference parameters. To study this bias, we conduct an experiment with 550 participants who made choices over lotteries from multiple price lists (MPLs). Following prior work, we manipulate the compromise effect to influence choices by varying the middle options of each MPL. We then estimate risk preferences using a discrete-choice model without a compromise effect embedded in the model. As anticipated, the resulting risk preference parameter estimates are not robust, changing as the compromise effect is manipulated. To disentangle risk preference parameters from the compromise effect and to measure the strength of the compromise effect, we augment our discrete-choice model with additional parameters that represent a rising penalty for expressing an indifference point further from the middle of the ordered MPL. Using this method, we estimate an economically significant magnitude for the compromise effect and generate robust estimates of risk preference parameters that are no longer sensitive to compromise-effect manipulations. Keywords Compromise effect · Cumulative prospect theory · Loss aversion · Risk preferences JEL Classification B49 · D03 · D14 · D83 · G11
Electronic supplementary material The online version of this article (https://doi.org/10.1007/s1068 3-019-09640-z) contains supplementary material, which is available to authorized users. * Jonathan P. Beauchamp [email protected] Extended author information available on the last page of the article
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1 Introduction The compromise effect arises when options in a choice set can be ordered on common dimensions or attributes (such as price, quantity, size, or intensity), and decision makers have a propensity to select the options in the “middle” of the choice set. In short, the compromise effect is a bias toward the middle option. For example, suppose a group of respondents were asked whether they wanted a free nature hike of either 1 mile or 4 miles. Now suppose that a different, otherwise identical group were asked whether they preferred a free nature hike of 1, 4, or 7 miles. A strong compromise effect would lead to a greater fraction of respondents choosing 4 miles in the second choice set (see Simonson 1989 for a closely related empirical result and Kamenica 2008 for a discussion of microfoundations). The compromise effect poses conceptual and practical problems for economic research. By influencing choices, the c
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