How wrong can you be? Implications of incorrect utility function specification for welfare measurement in choice experiments

Citation

Torres C, Hanley N & Riera A (2010) How wrong can you be? Implications of incorrect utility function specification for welfare measurement in choice experiments. Stirling Economics Discussion Paper, 2010-12.

Abstract
Despite the vital role of the utility function in welfare measurement, the implications of working with incorrect utility specifications have been largely neglected in the choice experiments literature. This paper addresses the importance of specification with a special emphasis on the effects of mistaken assumptions about the marginal utility of income. Monte Carlo experiments were conducted using different functional forms of utility to generate simulated choices. Multi-Nomial Logit and Mixed Logit models were then estimated on these choices under correct and incorrect assumptions about the true, underlying utility function. Estimated willingness to pay measures from these choice modelling results are then compared with the equivalent measures directly calculated from the true utility specifications. Results show that for the parameter values and functional forms considered, a continuous-quadratic or a discrete-linear attribute specification is a good option regardless of the true effects the attribute has on utility. We also find that mistaken assumptions about preferences over costs magnify attribute mis-specification effects.

Keywords
utility specification; attributes; welfare measurement; accuracy; efficiency; choice experiments; Monte Carlo analysis; Welfare economics

JEL codes

• C51: Model Construction and Estimation
• D69: Welfare Economics: Other
• C99: Design of Experiments: Other
• C15: Statistical Simulation Methods: General

• SEDP-2010-12-Torres-Hanley-Riera.pdf