Loss aversion, reference dependence and diminishing sensitivity in choice experiments

Highlights

• Loss aversion, reference dependence and varying sensitivity are inherent in choices made in stated choice experiments.

• Welfare measures change across models that differentially account for loss aversion, reference dependence and sensitivity.

• Status quo alternatives can be easily incorporated to reflect respondents' current situation.

Abstract

This paper tests for the existence of loss aversion, reference dependence and diminishing sensitivity in a discrete choice experiment (DCE). A status quo alternative is introduced in a DCE of nurses' job choices and modeled as an individual-specific third alternative representing the respondent's current job. This provides a feasible method for including a status quo, which changes the reference point for each respondent. The increased salience of the status quo changes the size of any losses or gains when comparing Job A or Job B with their current situation, and since losses are valued more than gains, affects the marginal utility of each attribute. Models that differentially incorporate loss aversion, reference dependence and changes in sensitivity yield varying estimates of marginal rates of substitution, suggesting that consideration of these effects is important, particularly when policy implications are sought.

Introduction

The design of policies and interventions to influence decisions requires an understanding of how decisions are made. For example, attempting to move people from their current set of choices to a new set of choices depends, according to standard economic theory, on the changes in costs and benefits. Economic theory assumes an attribute of a good or service is valued independently of context and that individuals have well-formed preferences (Hess et al., 2018; Shiell et al., 2000). Thus, choice tasks should generate attribute rankings that are consistent regardless of how they were elicited, but this is not observed in practice. Prospect theory (Kahneman and Tversky, 1979) recognises that reference points influence choices, and movements away from the reference point are evaluated in terms of gains and losses relative to this point. In a series of experiments, individuals were found to be more sensitive to losses than to gains when evaluating their options, and were generally risk-seeking when outcomes were losses, and risk-averse when outcomes were gains. This implies an s-shaped value function, where losses lead to larger reductions in value than equivalent sized gains. Using prospect theory, Thaler (1980) introduced the concept of the endowment effect that also helped explain the importance of the difference in value between losses and gains. If individuals view losses as out-of-pocket costs, and gains as forgone opportunity costs, then a good taken away from an individual's endowment will be weighted more heavily than the same good added to their existing endowment. Samuelson and Zeckhauser (1988) discuss status quo bias: decision makers choose the alternative that was their current situation more frequently than predicted by a rational choice model. They cite a range of examples from observations and experiments that support that status quo biases are ubiquitous and significant, and that the bias increases with the number of choice alternatives. The design of their experiments allows them to conclude that status quo bias is generally present, not just as a result of loss aversion (Samuelson and Zeckhauser, 1988). De Borger and Fosgerau (De Borger and Fosgerau, 2008) introduced a theoretical framework that maps choice pairs to different welfare measures and used this to compare four commonly used valuation measures that represent gains and losses in two dimensions from a reference point. They find loss aversion, reference dependence and diminishing sensitivity in an empirical application using data from a survey of binary choices where respondents trade off money and time. They also find that “mistakes”, defined as choosing a dominated alternative, are much more common when the reference scenario is dominated. In other words, respondents are more likely to choose their status quo, even if it is a dominated scenario.

The aim of this paper is to examine the effect of the status quo in the context of a discrete choice experiment (DCE). We present an application that integrates a scenario describing each respondent's current situation (their status quo) consisting largely of qualitative attributes into a DCE. We use data from a DCE of job preferences among nurses, where respondents were asked to choose their preferred alternative from a set of hypothetical scenarios, then asked to choose again from the same hypothetical scenarios and their current situation. The ‘current situation’ is an additional alternative reconstructed for each respondent from answers to questions that were phrased with the same description of attributes and levels used in the DCE, which offers a simple way to integrate any reference scenario into discrete choice experiments without loss of data.