THE CONTINGENT VALUATION METHOD

a) Early developments, applications and acceptability

E arly references to the C ontingent V aluation m ethod can be found in D av is's (1963a) analysis of the valuation of natural resources (outdoor recreational goods), Brookshire et al.(1980) and Haneman (1994). Some authors refer to a much earlier reference by Cinany-Wanturp in 1947 who suggested a direct interview method for valuing natural resources (see Mitchell and Carson 1989).

The Contingent Valuation method is a special case of the Stated Preference method, where a direct WTP question is asked in relation to presenting one alternative. The method uses a hypothetical scenario (or contingency), for example a ‘ specific decrease in noise levels’ in a residential area that is proposed by a new traffic scheme.

One of the earliest applications of the CVM (bidding games, where the interviewer suggests increases in the stated value until the maximum respondent’s WTP is obtained) for valuing non-use values focusing on aesthetic environmental improvements related to air quality and was developed by Randall, Ives & Eastman (1974) for the case o f ‘Four C orners’ area, USA. Other applications, also using an iterative bidding CV format, have been developed since, for example, by Brooskhire et al. (1982), which examined the value of clean air in the Los Angeles metropolitan area of California.

In the USA, early in 1979 the Water Resources Council set forth the Contingent Valuation method, together with the TCM, as accepted techniques for valuing the benefits of proposed water resources projects. In 1989, the well known Exxon Valdez oil spill off Alaska raised the question of the estimation o f non-use values in damage compensation. This led the NOAA (National Oceanic and Atmospheric Administration) in 1992, under the Oil Pollution Act (1990) to publish guidelines for the application of CV methods, the only acceptable and known method at that time to deal with the estimation of non-use values. These guidelines

contain recommendations in order to avoid potential biases associated with the application of this survey technique. In the USA, the World Bank also uses the CVM for assessing various investments proposed for funding by underdeveloped countries (e.g. Valuation of Tropical Forests o f Madagascar, 1995). However, following the proceedings o f a conference on CV sponsored by the US Department of Energy in 1994, there seems still to exist a lot of debate on the overall acceptability o f the CV method as a preferred valuation technique (see also Carson, 1996).

In the UK, the CVM has never been explicitly recommended by any governmental department, although the Department of the Environment, Transport and the Regions had funded research associated with the applicability o f other disaggregate approaches within the stated preference arena, not necessarily CV (see for example, Conference Proceedings on ‘Determining Monetary Values o f Environmental Impacts’ (University of Westminster 1997). Recently, the UK Department for Transport, Local Government and the Regions commised a study on using stated preference techniques, including the contingent valuation method (Pearce and Ozdeminroglu al. 2002).

b) T heoretical principles and assum ptions

The Contingent Valuation approach is a demand curve approach which can in theory estimate the true Hicksian welfare measures for changes in the provision o f an environmental good (see demonstration in Bateman and Turner 1992 ). This relies on the method to elicit direct questions o f how much income consumers are willingness-to-pay (WTP) to ensure that a welfare gain occurs e.g. due to environmental quality improvements, or how much income they are willing to accept to have a welfare loss. The theoretical principles can be found in Hicks (1943) as already referred through the concepts of compensating and equivalent variation (hereafter referred to as CV and EV), money measures o f a change in utility (consumer surplus measures related to the WTP and WTA- willingness-to-accept). These can express welfare gains (benefits) or welfare losses (costs).

In a CV scenario, the reference level is the one before the change has taken place (reference state), so one may ask what is the individual’s WTP for that change such as the utility level is the same as before the economic change (e.g. price changes o f environmental goods or decrease in levels of the bad). The amount that an individual would be WTP for that change is finite and limited by income (Layard and Walters, 1978). On the other hand, if one asks

the amount an individual would be willing to accept as compensation for the change (e.g.

associated to an increase in the levels o f a bad such as noise that will correspond to a welfare loss), this amount could be infinite.

Considering that individuals derive utility U from an environmental good A such as environmental quality and market goods G:

U = U[ A, G]

the correspondent indirect utility function (see glossary) is:

V* = V[ P g , A , l ]

where / is the household budget.

The CV valuation approach asks respondents to state the income adjustment - WTP or WTA for a change in the environmental quality from Ao to A ], This is equivalent to say that the CV survey (max WTP statements) will identify points on the inverse compensated demand function WTP = P(A,U°) so th a t:

v[a o,i] = v[a]i - w t p\

In the referendum approach where a change in environmental quality is identified together with a proposed WTP* amount, the respondent indicates yes (acceptance) or no (rejection) of the inequality:

V[A,, I - WTP *] >< V[A0 l\

and if the survey WTP* is a lower or upper bound of the ‘true’ WTP.

Recent developments in theory (e.g. Knetsch (1990) and Haneman (1991), Adamowicz et al.

(1993)) show that WTP and WTA can differ significantly because o f the substitution effects and also because indifference curves may be ‘kinked’. Other effects can explain this difference such as income effects (Hicks consumer theory) and psychological phenomenon such as loss aversion.

In practice, the CV approach integrates several steps, and some issues can be associated to each one :

1) Scenario building, which involves the setting up o f an hypothetical market (verify contents validity, i.e. make sure that the contingent market makes sense so that it can be easily understood by respondents);

2) Bid Vehicle definition, i.e. how WTP for a specific change will be administered (face- to-face interview, mail, telephone or combination o f these, computer-based);

3) CV question format, which involves the choice of type of CV surveys to be administered to a specific population in order to get bids (WTP or WTA). This can involve formats that generate continuous data, or discrete data. The former ones include open-ended

elicitation questions (ask maximum WTP without suggesting any value), and the offer of payment cards (range o f typical/chosen values is presented in a card and respondents

choose the appropriate one). The most used discrete CVM is the simple dichotomous choice format (ask if WTP is greater or less than a printed value), but others include the iterative bidding method (higher values are continuously suggested to individuals until they state their maximum WTP), and the simple referendum4, where respondents have to answer yes or no to a specific payment suggested;

4) Mean WTP/WTA estimation, i.e. calculate an average bid for the population surveyed (overcome problems such as protest bids, e.g. modelling them as zero bids, and exclude outliers when mean value is used, and ‘don’t know’ responses). In a closed-ended CV format, for example, a logit equation that relates the probability of a positive answer to each suggested amount can be estimated; Wang (1997) provided a utility-theoretical interpretation (random valuation model) for the treatment of ‘don’t know’ (DK) responses in the CV surveys, so that one can avoid the loss of choice information with DK answers.

5) Bid Curves Estimation, i.e. bid curves can be estimated for example using WTP values as the dependent variable, and regressed on several independent variables (income levels, age, levels of degradation in air quality, etc.) using Ordinary Least Squares (OLS) or Maximum Likelihood.

6) Aggregation Process, i.e. the process whereby the bids are converted to a population total value figure (use total bid or mean bid and verify if total economic value figures when decomposed into use and non-use values are coherent, and see if the sample is representative of the population).

c) Theoretical Consistency

In the application of the CVM, several biases can be associated to each step and to a specific choice format, and so invalidating estimates:

• In cases where an initial bid is suggested to respondents, this might lead to the formation o f a different range of final bids in respondent’s minds (starting point bias). For example, Rowe et al. (1980) in a CV-bidding game for valuing visibility, found that an increase in $1 in the starting bid resulted in a SO.6 increase in the final bid. It is also interesting to note, as referred by Brookshire et al. (1982) that if the starting bid is significantly different from the respondent’s actual WTP, the respondent may become

4 Referendum CV questions are also called closed-ended, dichotomous choice, or take-it-or- leave-it CV questions (see also Cameron and Huppert, 1991).

bored with the bidding game and truncate the process before she/he can state actual WTP.

• In the case of proposed improvements in environmental quality, e.g. in residential areas, respondents may think that stated bids will be collected in the future, so they understate their WTP (strategic bias). Policy changes that involve environmental goods that are non-excludable in consumption, will inevitably face the free-rider problem.

• If respondents are not familiar with the good being valued or they do not have enough information on those changes (e.g. health effects o f air pollution due to air quality changes), they might state WTP with a large random error term (hypothetical bias).

• Other potential biases can be found in the literature, and include mental account bias (if an individual bids an amount based on a weighted allocation o f a calculated environmental budget that takes into account time and money constraints), choice o f bid vehicle bias or instrument bias (e.g. in the case of an entry fee in a commercial area where improvements in air quality are proposed, one will probably not get the same WTP if the bid-vehicle is for example ‘donations for improving public transport’, or simply money units), compliance bias (if respondents give answers that they believe the questioners would find most satisfactory), etc.

Respondent experience (or information) of the environmental goods is accepted as an influence on CV survey results. Cameron and Englin (1997), for example, have developed an econometric framework to address the issue of whether the level and precision of WTP for environmental resources is systematically related to respondent's own experience with the good. Their findings support the view that some minimum experience is required before the referendum CV willingness-to-pay responses may be considered credible.

In order to avoid these potential biases, several authors and organisations have issued guidelines to CV surveys. The US NOAA guidelines, as already mentioned in this section, are the most popular in the world (see also Griffin et al. (1995), Brookshire and Neill (1992)). Here, a summary o f the main recommendations is pointed out:

• Conduct direct interviews (in person) rather than on the telephone;

• Make the questions about a future, hypothetical occurrence rather than a historical event;

• Choose referendum formats in which respondents vote on a benefit with a known price (as opposed to open-ended questions);

• Begin interviews with a scenario accurately describing the benefits o f the program;

• Remind in the survey that the payment for the new benefit reduces other consumption;

• Remind respondents in the survey that substitutes exist for the hypothetical benefit in question;

• Do follow-up questions to make sure that respondents understand the choices made.

Concerning the CV format, most o f authors believe that the process o f answering a dichotomous choice valuation question is more similar to an individual’s actual purchase or voting decision (Ready et al. 1996; Boyle and Bishop 1988; US Federal Register 1993).

While avoiding some o f the biases inherent in the open-ended format, the CV referendum approach has less informational efficiency, as the analyst can only identify upper or lower bounds on the individual’s underlying valuations.

Recently, McFadden (1994) found that open-ended welfare estimates were smaller than the comparable dichotomous-choice welfare measures for the case ot protection of the wilderness. This led him to the conclusion that statistical congruence of both type of questions will depend on the type of good being valued. Procedural invariance is established by test o f convergent validity of individual moments of the open-ended and dichotomous-choice distributions. If all ‘moments’ o f both distributions are statistically congruous, procedural invariance is established. However, evidence on the statistical congruence o f open-ended and dichotomous-choice questions is mixed: procedural invariance may occur for private goods but is not likely to occur when primarily estimating nonuse values (Boyle et al. 1996).

Seller et al. (1985) in a validation study o f empirical measures o f welfare changes, have also demonstrated that the open-ended format o f the CVM provided very low estimates of consumer’s surplus, and the negative values found in the cases studied indicate problems with this approach. However, the closed-ended format provided comparable estimates of consumer’s surplus for the environmental assets valued with the ones that were derived from the application of other valuation techniques.

Cummings, Brookshire and Schulze (1986) referred to the use o f mixed formats, e.g.

using payment cards to establish initial bids and then conduct the bidding game from this starting point. This alternative survey strategy may lead one to think that mixed sequential CV formats might have a role to play in the valuation o f environmental changes.

An extensive number o f CV studies exist, and these will be discussed in the next chapter.

However, there exists also an extensive number o f potential problems to overcome. The problem o f embedding (Kahneman 1986; Kahneman and Knetsch 1992) refers to the solicitation of WTP estimates for a good that is valued as a component o f a larger one (e.g.

if the survey analyst obtains a similar value for cleaning up one lake and two lakes). Existing studies found that embedding a good significantly lowers the amount that respondents say

they would pay for the environmental good in question, compared to a non-embedded valuation (see for example Brown et al. 1995). This can be interpreted as indicating that people perceive related public goods to be close substitutes, so adequate information shall be presented to respondents in the CV survey. However, some recent critics o f the CVM (such as Diamond and Hausman, 1994) present embedding as a theory inconsistency.

Other problems are referred to in the literature, such as nesting and sequencing (Horowitz 1993). The former occurs when different (but comparable) groups of individuals report a WTP for environmental improvements that does not vary with the scale (or scope) o f the projects in question, and the latter occurs when various projects (e.g. environmental improvements) are being evaluated through sequential questions and WTP is lower for an alternative if it is second in the list (than in the case where it was the former).

d) Major drawbacks and/or advantages if applied to value traffic noise

Like any valuation method, the CV approach does not work well in all circumstances, and this is the case when information on the environmental good in question is low, uncertainties are considerable (e.g. health effects of noise suffered at home) or the effects are too complex (e.g. multiple or cumulative effects) to be described and understood by individuals.

However, the CVM has already proved in various cases, e.g. in the valuation of natural resources, to be a reliable valuation technique and correct survey design and procedures followed during the survey aree fundamental. In the literature reviewed, several studies were found on comparisons between CV and other valuation methods, and Haneman (1994) states that more than 80 studies exist offering several hundred comparisons, and results are very close.

The use of the CVM in the context o f valuation o f noise externalities is possible, bearing in mind that potential biases shall be overcome. However, consumer surplus measures derived from this method have to be compared with other methods (i.e. alternative valuation approaches) in order to validate estimates (convergent validity). Table 2.4 makes a synthesis o f the main items covered for the CVM method.

Table 2.4: Sythesis Table of the Contingent Valuation Method. Type of Applications (Generic) WTP (and WTA) compensation Governmental and others acceptability US Water Resources Council in 1979

US NO A A (1992)- see Arrow et al.(1993) Preferred Suitability Benefits estimation/Environmental quality

changes; Valuation o f changes in the provision of environmental goods/services

Assumptions Hicks welfare measures

Necessary Data to Collect (Independent variables)

Consistency with Practical Issues Several potential biases to avoid (strategic bias, starting point bias, etc.), other problems to overcome (protest bids, WTA outliers, sample to be representative of the population) Validity It is not possible to validate the hypothetical

responses (future noise changes) of the interviewed population through actual market behaviour; However, one can compare estimates of consumer surplus derived by the application of different techniques (convergent validity).

More recent variants of the CV Dichotomous-choice format

Bidding games with information provided to respondents

Mixed sequential formats

2.3.5 T H E ST A T E D PR EFER E N C E M E T H O D

a) Early developments, applications and acceptability

Following the developments o f the Stated Preference - CVM in the late 70s, other disaggregate valuation approaches using functional measurement and conjoint analysis have

emerged from consumer, psychology and marketing research ideas (Luce and Suppes 1965;

Green and Rao, 1971; Green and Srinivasan 1978). They have been first applied in the transport domain for fulfilling the needs of forecasting travel demand and behaviour in situations where traditional travel demand models were inadequate (for example due to poor quality or lack o f data).

In the UK, SP techniques have already proved to be useful and reliable forecasting tools of travel demand (W ardman 1987, and Pearmain and Kroes 1990; Wardman and Fowkes 1991). SP techniques have been used with success for valuing non-market attributes such as time savings, at the local (Fowkes et al. 1985; Wardman 1987) and national level. Examples are the UK value o f time study (MVA/ITS/TSU 1986) and the Netherlands value o f time study (Accent Marketing and Hague Consulting Group

1994). Some applications o f stated preference techniques for valuing traffic noise will be reviewed in Chapter 3. Other recent applications o f SP techniques include the valuation o f accidents (Rizzi and Ortuzar 2001) and atmospheric pollution (Ortuzar and Rodriguez 2002).

The family o f Stated Preference (SP) techniques described in this section as SP-choice, SP- ranking and SP-rating rely on decompositional (disaggregate) methods for modelling individual’s behaviour (e.g. housing choices) when they are faced with a set of mutually exclusive and exhaustive alternatives (e.g. apartment options) which are described as a bundle o f attributes. The SP survey design is more complex than the CV one, but existing catalogues of plans/factorial designs based on number of attributes and correspondent levels (Cochrane and Cox 1957; Kocur et al. 1982) simplify the task to the survey analyst guaranteeing that main effects and interaction effects are independent o f each other (zero correlation between attributes). The use of orthogonal designs (attributes are independently distributed) was questioned by Fowkes and Wardman (1993), as a certain degree of correlation can be desirable is some situations.

The taxonomy for SP methods presented in this section is based on the types of response data (see also Bradley and Kroes 1990):

1. SP-choice - the respondent chooses the best alternative from the set o f possible ones (metric response scale from which the analyst can derive the strength o f preference). In practice there is a tendency to limit the number o f choices given to respondents and the number o f its attributes per each alternative (maximum is usually 5), as a high number can affect the quality of respondent’s answers due to fatigue. The process o f estimation

of individual's preferences is based on random utility theory and uses discrete choice models;

2. SP-rating or scaling - the respondent rates or scores alternatives presented to them according to a numerical (e.g. on a scale 0-10) or semantic preference scale (response indicates strength and order of preference). The most common processes o f estimating individual’s preferences are Regression Analysis (scale assumed is linear and continuous) or Ordered Probit Analysis (an interval scale is assumed).

3. SP-ranking - groups of alternatives are compared against each other, so they can be ordered from individual’s stated preferences (ordinal response or conjoint measurement derived from a series of trade-offs). Rank ordering can also be treated as a set of independent choices, such that discrete choice models can be used.

The applicability o f statistical methods depends on the scale in which variables are measured i.e. interval or metric scale', nominal; ranked or ordinal scale, and the appropriateness o f each estimation technique rely on statistical and choice modelling theories. Metric rating scales yield more information than ordinal scales (Wardman 1987;

Mackenzie 1993). Ratings provide information on preference intensities and can uniquely

Mackenzie 1993). Ratings provide information on preference intensities and can uniquely