Abstract
We extend the Berry, Levinsohn and Pakes (BLP, 1995) random coefficients discrete choice demand model, which underlies much recent empirical work in IO. We add interactive fixed effects in the form of a factor structure on the unobserved product characteristics. The interactive fixed effects can be arbitrarily correlated with the observed product characteristics (including price), which accommodates endogeneity and, at the same time, captures strong persistence in market shares across products and markets. We propose a two-step least squares-minimum distance (LS-MD) procedure to calculate the estimator. Our estimator is easy to compute, and Monte Carlo simulations show that it performs well. We consider an empirical illustration to US automobile demand.
Highlights
The Berry et al (1995) demand model, based on the random coefficients logit multinomial choice model, has become the workhorse of demand modeling in empirical industrial organization and antitrust analysis
We focus on the case where these unobserved product characteristics vary across products and markets according to a factor structure: ξj0t = λ0j ′ ft0 + ejt, (2.3)
We consider an extension of the popular BLP random coefficients discrete-choice demand model, which underlies much recent empirical work in IO
Summary
The Berry et al (1995) (hereafter BLP) demand model, based on the random coefficients logit multinomial choice model, has become the workhorse of demand modeling in empirical industrial organization and antitrust analysis. The nested simulated GMM procedure proposed by BLP accommodates possible endogeneity of the observed product-specific regressors, notably price. This model and estimation approach has proven very popular Bai and Ng (2006), Bai (2009), and Moon and Weidner (2015, 2017)), we extend the standard BLP demand model by adding interactive fixed effects to the unobserved product characteristic, which is the main ‘‘structural error’’ in the BLP model This interactive fixed effect specification combines market (or time) specific fixed effects with product specific fixed effects in a multiplicative form, which is often referred to as a factor structure
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