Choice Models and Permutation Invariance: Demand Estimation in Differentiated Products Markets

TL;DR

This paper introduces a flexible, data-driven approach to demand estimation in differentiated products markets using choice models that are permutation invariant, leveraging neural networks to improve accuracy and handle endogenous features.

Contribution

It provides a new characterization of choice functions, demonstrates neural network estimators' effectiveness, and extends the framework to endogenous features with formal inference procedures.

Findings

Neural network estimators outperform traditional parametric models.

The proposed method accurately captures consumer behavior in simulations.

Empirical analysis yields realistic price elasticities consistent with literature.

Abstract

Choice modeling is at the core of understanding how changes to the competitive landscape affect consumer choices and reshape market equilibria. In this paper, we propose a fundamental characterization of choice functions that encompasses a wide variety of extant choice models. We demonstrate how non-parametric estimators like neural nets can easily approximate such functionals and overcome the curse of dimensionality that is inherent in the non-parametric estimation of choice functions. We demonstrate through extensive simulations that our proposed functionals can flexibly capture underlying consumer behavior in a completely data-driven fashion and outperform traditional parametric models. As demand settings often exhibit endogenous features, we extend our framework to incorporate estimation under endogenous features. Further, we also describe a formal inference procedure to construct valid confidence intervals on objects of interest like price elasticity. Finally, to assess the practical applicability of our estimator, we utilize a real-world dataset from S. Berry, Levinsohn, and Pakes (1995). Our empirical analysis confirms that the estimator generates realistic and comparable own- and cross-price elasticities that are consistent with the observations reported in the existing literature.