See, there's a difference between your situation and the dragon. There was no sense from the player that the dragon would negotiate. It was 2 choices - die with the NPC or walk away. There was no third option.
My issue with this is, you've set it up that a paladin can never actually fail. You might not get a total success, but, you can't actually fail because any failure is automatically a violation of an oath. So, the DM is forced to allow you to succeed every time.
So, you negotiate, the entire party is killed then the peasants are killed. Maybe the peasants are even killed in nastier ways because now the baddies are really angry because you resisted them.
I prefer scenarios where failure is possible. If I tell the players that there is an overwhelming force coming, then, you can bet that that force is overwhelming and standing up like that is suicidal and will accomplish nothing. It seems like you and
@pemerton are saying that I should always have other options available and that those other options will always come true.
Talk to the dragon and negotiate. Talk to the overwhelming force. No problems, it will work out because the DM will step in and make sure that nothing really bad will happen to you.
To me, failure is FAR more interesting.
As a player, I'd be ok with the 3rd outcome if we flubbed our dice rolls; if we had no chance to survive it might seem like unfair GMing. But out PCs would still have done the right thing in-universe.
See, to me, it's not. It's reckless, pointless and a total violation of what a paladin should be. Throwing away your lives on pointless gestures that accomplish nothing is not in keeping with what a paladin should be.
Good grief, imagine what a paladin army would be like? Incredibly stupid and easily destroyed because all you have to do is threaten some innocents, make sure you have an overwhelming force, and every paladin smiles as he jumps on your swords. Yeah, I don't think so.