The impact of perceptions in averting-decision models: An application of the special regressor method to drinking water choices

Households' monetary valuation of water quality is a prerequisite for efficient water resource management and the valuation of water quality protection policies. Individuals are commonly questioned about their perception of risk in valuation surveys based on stated-preference methods and revealed-preference methods such as averting-behavior models. These subjective and often discrete measures are commonly used to explain individuals' actions to protect themselves against these risks. Perceptions appear as endogenous variables in traditional theoretical averting-decision models but, quite surprisingly, endogeneity of perceived risk is not always controlled for in empirical studies. In this article, we argue that perceptions have to be treated as endogenous to averting decisions in order to produce accurate and reliable measures of households' valuation of water quality improvements. We present various binary averting decision models featuring an endogenous discrete variable (such as risk perception). In particular, we compare the traditional bivariate probit model with the special regressor model, which is less well-known and relies on a different set of assumptions. In the empirical illustration using household data from Australia, Canada, and France, we study how the perceived health impacts of tap water affect a household's decision to drink water from the tap. Individuals' perceptions are found to be endogenous and significant for all models, but the estimated marginal effect is sensitive to the chosen model. Our empirical application also includes some tests of the special regressor estimator's sensitivity to underlying assumptions.