Testing the Validity of a Demand Model: An Operations Perspective

Manufacturing & Service Operations Management, Vol. 12, No. 1, pp. 162-183, Winter 2010

Columbia Business School Research Paper No. 11-18

22 Pages Posted: 19 Oct 2011

See all articles by Omar Besbes

Omar Besbes

Columbia Business School - Decision Risk and Operations

Robert Phillips

Columbia Business School - Decision Risk and Operations

Assaf Zeevi

Columbia Business School - Decision Risk and Operations

Date Written: 2010

Abstract

The fields of statistics and econometrics have developed powerful methods for testing the validity (specification) of a model based on its fit to underlying data. Unlike statisticians, managers are typically more interested in the performance of a decision rather than the statistical validity of the underlying model. We propose a framework and a statistical test that incorporates decision performance into a measure of statistical validity. Under general conditions on the objective function, asymptotic behavior of our test admits a sharp and simple characterization. We develop our approach in a revenue management setting and apply the test to a data set used to optimize prices for consumer loans. We show that traditional model-based goodness-of-fit tests may consistently reject simple parametric models of consumer response (e.g., the ubiquitous logit model), while at the same time these models may "pass" the proposed performance-based test. Such situations arise when decisions derived from a postulated (and possibly incorrect) model generate results that cannot be distinguished statistically from the best achievable performance - i.e., when demand relationships are fully known.

Suggested Citation

Besbes, Omar and Phillips, Robert and Zeevi, Assaf, Testing the Validity of a Demand Model: An Operations Perspective (2010). Manufacturing & Service Operations Management, Vol. 12, No. 1, pp. 162-183, Winter 2010 ; Columbia Business School Research Paper No. 11-18. Available at SSRN: https://ssrn.com/abstract=1946376

Omar Besbes (Contact Author)

Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States

Robert Phillips

Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States

Assaf Zeevi

Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States
212-854-9678 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www.gsb.columbia.edu/faculty/azeevi/

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