Valuation Techniques for Social Cost-Benefit Analysis: - HM Treasury

As a minimum value estimates should be fully explained to acknowledge the utility derived from
the consumption of complementary goods. A preferred approach (if possible) would be to
control for the consumption of complementary goods or to subtract the market price of the
complementary goods from the overall value estimate.
8. Time-invariant factors such as personality traits should be controlled
for (panel data estimation only).
In practice, the life satisfaction regression is estimated assuming the existence of time-invariant
unobserved determinants ( i ) of well-being. The life satisfaction variable is ordinal in nature but
Ferrer-i-Carbonell and Frijters (2004) show that assuming cardinality as opposed to ordinality in
the LS function makes no difference to estimation results. For ease of estimation and exposition,
the preferred model has therefore become an OLS regression with fixed effects to control for i :
LSit M it Qit
X
(24)
1 2 3 it i it
Fixed effects models work by using the longitudinal nature of the data to control for
determinants of life satisfaction which do not change over time ( i ). This might include
characteristics such as extroversion and introversion which are strongly associated with wellbeing
or factors such as an innate tendency / ability to be happy or satisfied. Because these
factors do not change over time they can be controlled for using a separate intercept for every
individual in a fixed effects model.
Random effects models can also control for i but it makes the assumption that the individual
effect i is uncorrelated with the other regressors in the model ( X ).This assumption is not
it
likely to hold in the life satisfaction function as we would expect factors such as extroversion to
be strongly correlated with some of the covariates included in the model.
9. Adaptation effects
Evidence suggests that many people adapt quickly to many positive and negative life events,
including marriage, divorce, disability, pay rises and unemployment (Brickman et al. ; Larsen and
Prizmic, 2008 (Eid and Larsen eds); Frijters et al, 2008). Adaptation effects can be estimated
using panel data and by including time-lagged explanatory variables for the good being valued.
For example, the life satisfaction of individual i in period t could be written as:
LSit 1 Mit
2Qit
3Qit
1 4X
it i it
(25)
The time-path effect of the non-market good (Q) is captured by parameters 2 and 3 . Here,
the good (Q) occurred or was consumed in the previous period (t-1) and so Qt picks up any
adaptation effects. If there is adaptation to Q, then
5 . Of course, specifications can be
adopted with further lags into past periods. The value of the good should be estimated for the
good‘s entire time-path as follows:
2 3
WTP ( years : t 1 t)
(26)
5 If there is adaptation to a non-market ‗bad‘ then
1
2
.
3
2
3
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