Nonparametric Identification of Demand without Exogenous Product Characteristics

TL;DR

This paper demonstrates that demand counterfactuals in differentiated products can be nonparametrically identified using recentered instruments under weaker conditions than previously thought, even with endogenous product characteristics.

Contribution

It introduces recentered instruments and the faithfulness condition, expanding nonparametric identification methods for demand models with endogenous characteristics.

Findings

Price counterfactuals are nonparametrically identified with recentered instruments.

Faithfulness is a weaker, yet essential, condition for identification.

Practical implications for demand estimation are discussed.

Abstract

We study identification of differentiated product demand from market-level data when product characteristics can be endogenous. Past work suggests nonparametric identification may be impossible: that is, in addition to standard price instruments, exogenous characteristic-based instruments are essentially necessary to identify sufficiently flexible demand models with standard index restrictions. We show, however, that price counterfactuals are nonparametrically identified using recentered instruments -- which combine exogenous price instruments with possibly endogenous product characteristics -- under a weaker index restriction and a new condition we term faithfulness. We argue that faithfulness, like the usual completeness condition for nonparametric instrumental variable identification, is best viewed as a technical requirement on the strength of identifying variation rather than a substantive economic or statistical restriction. We show the two conditions are closely related, though generally distinct. We conclude with several practical implications for the parametric estimation of demand counterfactuals.