Abstract
Intertemporal preference reversals occur when individuals choose future option A over future option B in a direct choice between the two but place a higher ‘immediate cash’ value on B than on A. Tversky et al. (1990) reported strong evidence of such reversals, which they attributed mainly to valuation biases rather than intransitivity. We find similar levels of reversals, even after adjusting for considerable degrees of variability and imprecision in people’s responses. However, we disagree with Tversky et al.’s conclusions about the causes of the majority of these reversals. We find substantial levels of intransitivity in respondents’ binary choices as well as differential overvaluation of both options relative to the values inferred from their choices.
Highlights
The preference reversal (PR) phenomenon is probably best known in the context of risky choice, where it refers to the evidence that individuals often choose an option with lower risk and smaller returns over an alternative option with greater risk and larger returns, while placing a higher certainty equivalent value on the $-bet than on the P-bet when evaluating the two options separately
We suggest that our study improves on TSK’s classic study in four important ways: (i) it uses all of the observed reversals, not just a subset; (ii) it can measure both undervaluation and overvaluation for both options; (iii) it makes allowance for the noise and imprecision in people’s responses – and it sheds new light on the degree of such imprecision in the area of intertemporal choice, where there are very few such data at the moment; and (iv) it explores the use of an additional instrument – the choice list – that has become popular among experimenters to supplement standard binary choice and direct valuation methods (Cheung, 2015; Laury et al, 2012)
Do we observe the PR phenomenon reported by TSK when binary choices between SS and LL are compared with central tendency measures of responses to the Direct Valuation (DV) questions? Second, do the reversals persist if valuations are derived as stochastic present value (SPV) from the Binary Choice (BC)? Third, do our data support or modify or contradict the conclusions about the causes of PR proposed by TSK?
Summary
The preference reversal (PR) phenomenon is probably best known in the context of risky choice, where it refers to the evidence that individuals often choose an option with lower risk and smaller returns (labelled a P-bet) over an alternative option with greater risk and larger returns (labelled a $-bet), while placing a higher certainty equivalent value on the $-bet than on the P-bet when evaluating the two options separately. It has been suggested that preferences, far from being deterministic, are often rather imprecise, and that such imprecision may produce the observed asymmetries (Butler & Loomes, 2007; MacCrimmon & Smith, 1986) Another possible implication of the imperfectly formed nature of people’s preferences is that responses to different tasks (e.g. choice as distinct from valuation) are ‘constructed’, often using somewhat diverse cognitive processes subject to different influences or biases (see Tversky et al, 1988). To investigate the generality of their ‘overvaluation-undervaluation’ diagnosis, TSK conducted a second experiment, looking at time preferences rather than risky choices Their Study 2 design revolved around five amounts to be received (hypothetically) at various times in the future, ranging from $3550 in 10 years’ time to $1525 in six months, as well as two levels of immediate cash amounts ($1250, $1350). Because we wished to achieve a high level of comparability with the TSK study, we opted for the latter
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