Estimation of Random Coefficient Demand Models: Challenges, Difficulties and Warnings

Christopher Knittel and Konstantinos Metaxoglou

No 14080, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Empirical exercises in economics frequently involve estimation of highly nonlinear models. The criterion function may not be globally concave or convex and exhibit many local extrema. Choosing among these local extrema is non-trivial for a variety of reasons. In this paper, we analyze the sensitivity of parameter estimates, and most importantly of economic variables of interest, to both starting values and the type of non-linear optimization algorithm employed. We focus on a class of demand models for differentiated products that have been used extensively in industrial organization, and more recently in public and labor. We find that convergence may occur at a number of local extrema, at saddles and in regions of the objective function where the first-order conditions are not satisfied. We find own- and cross-price elasticities that differ by a factor of over 100 depending on the set of candidate parameter estimates. In an attempt to evaluate the welfare effects of a change in an industry's structure, we undertake a hypothetical merger exercise. Our calculations indicate consumer welfare effects can vary between positive values to negative seventy billion dollars depending on the set of parameter estimates used.

JEL-codes: C1 C61 C81 L1 L4 (search for similar items in EconPapers)
Date: 2008-06
New Economics Papers: this item is included in nep-ecm
Note: IO TWP
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Citations: View citations in EconPapers (21)

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