Ghborhood choice into (1) the average utility that individuals derive from unobserved

Ghborhood choice into (1) the average utility that individuals derive from unobserved neighborhood characteristics (j) and (2) random individual deviations in the utility (ij). The utility function can be written:(6.1)NIH-PA Author Manuscript NIH-PA Author Manuscript NIH-PA Author Manuscriptwhere pj order Peretinoin denotes the average house price in the jth neighborhood. The negative coefficient indicates that neighborhood utility varies inversely with housing prices, all else equal. The endogeneity problem is that prices depend on both observed and unobserved attributes of neighborhoods that affect desirability and thus demand. In other words, prices are a function of j. The solution is to introduce a constant for each neighborhood that captures its average utility (based on both observed and unobserved characteristics). This moves j out of the error term and into this alternative specific constant. Rearranging terms in (6.1), we have(6.2)where the term in brackets does not vary over individuals. If we denote the alternative specific constants as j = Zj-pj + j, then(6.3)Sociol Methodol. Author manuscript; available in PMC 2013 March 08.Bruch and MarePageThis choice model no longer has an endogeneity problem because the j are subsumed into the alternative specific constants, which can be estimated along with the other parameters of the model. (We present this solution for the standard conditional logit model, but this strategy can also be applied to other models, including the mixed logit model). This model provides estimates of the alternative specific coefficient and the remaining parameters for choice behavior. HS-173MedChemExpress HS-173 However, the parameters associated with the utility for a given neighborhood that is common to all individuals remain subsumed in the j. Fortunately, because these parameters enter the definition of the alternative specific constants linearly, they can be treated as outcomes in a regression model where the dependent variable is the alternative specific constant and the explanatory variables are characteristics of the neighborhood, including price. Here j is endogenous, but there are well-developed IV procedures for handling endogeneity in a linear model. The practical problem with this approach is that when the number of alternatives is large it is not feasible to estimate the alternative specific constants. Berry Levinson, and Pakes (1995) provide an algorithm for estimating these parameters when there is a large number of alternatives. Bayer and colleagues (Bayer and McMillan 2005, 2008; Bayer, McMillan, and Rueben 2004) use this method in their analyses of residential choice and segregation dynamics. To obtain consistent estimates of the relationship between housing costs and mobility behavior, they divide their discrete choice utility function into a house-specific fixed effect, j, and individual-specific interaction component, ij such that Uij = j + ij + ij. They estimate model parameters using an iterative two-step procedure. In step 1, estimate the parameters in ij and the average utilities j using a discrete choice model in step 2, instrument for prices to recover the parameters in j. The authors use a measure of the relative scarcity of a given housing unit or neighborhood in the housing market as the instrument. Neighborhoods that are unique or occur less frequently, for example, a perfectly racially mixed area that contains new housing stock, command higher prices assuming there is some demand.NIH-PA Author Manuscript NIH-PA Author.Ghborhood choice into (1) the average utility that individuals derive from unobserved neighborhood characteristics (j) and (2) random individual deviations in the utility (ij). The utility function can be written:(6.1)NIH-PA Author Manuscript NIH-PA Author Manuscript NIH-PA Author Manuscriptwhere pj denotes the average house price in the jth neighborhood. The negative coefficient indicates that neighborhood utility varies inversely with housing prices, all else equal. The endogeneity problem is that prices depend on both observed and unobserved attributes of neighborhoods that affect desirability and thus demand. In other words, prices are a function of j. The solution is to introduce a constant for each neighborhood that captures its average utility (based on both observed and unobserved characteristics). This moves j out of the error term and into this alternative specific constant. Rearranging terms in (6.1), we have(6.2)where the term in brackets does not vary over individuals. If we denote the alternative specific constants as j = Zj-pj + j, then(6.3)Sociol Methodol. Author manuscript; available in PMC 2013 March 08.Bruch and MarePageThis choice model no longer has an endogeneity problem because the j are subsumed into the alternative specific constants, which can be estimated along with the other parameters of the model. (We present this solution for the standard conditional logit model, but this strategy can also be applied to other models, including the mixed logit model). This model provides estimates of the alternative specific coefficient and the remaining parameters for choice behavior. However, the parameters associated with the utility for a given neighborhood that is common to all individuals remain subsumed in the j. Fortunately, because these parameters enter the definition of the alternative specific constants linearly, they can be treated as outcomes in a regression model where the dependent variable is the alternative specific constant and the explanatory variables are characteristics of the neighborhood, including price. Here j is endogenous, but there are well-developed IV procedures for handling endogeneity in a linear model. The practical problem with this approach is that when the number of alternatives is large it is not feasible to estimate the alternative specific constants. Berry Levinson, and Pakes (1995) provide an algorithm for estimating these parameters when there is a large number of alternatives. Bayer and colleagues (Bayer and McMillan 2005, 2008; Bayer, McMillan, and Rueben 2004) use this method in their analyses of residential choice and segregation dynamics. To obtain consistent estimates of the relationship between housing costs and mobility behavior, they divide their discrete choice utility function into a house-specific fixed effect, j, and individual-specific interaction component, ij such that Uij = j + ij + ij. They estimate model parameters using an iterative two-step procedure. In step 1, estimate the parameters in ij and the average utilities j using a discrete choice model in step 2, instrument for prices to recover the parameters in j. The authors use a measure of the relative scarcity of a given housing unit or neighborhood in the housing market as the instrument. Neighborhoods that are unique or occur less frequently, for example, a perfectly racially mixed area that contains new housing stock, command higher prices assuming there is some demand.NIH-PA Author Manuscript NIH-PA Author.