Search with Dirichlet Priors: Estimation and Implications for the Price Elasticity of Demand

29 Pages Posted: 16 Sep 2015

See all articles by Sergei Koulayev

Sergei Koulayev

Consumer Financial Protection Bureau

Date Written: September 14, 2013

Abstract

This article is an empirical application of the search model with an unknown distribution, as introduced by Rothschild in 1974. For searchers who hold Dirichlet priors, we develop a novel characterization of optimal search behavior. Our solution delivers easily computable formulas for the ex-ante purchase probabilities as outcomes of search, as required by discrete-choice-based estimation. Using our method, we investigate the consequences of consumer learning on the properties of search-generated demand. Holding search costs constant, the search model from a known distribution predicts larger price elasticities, mainly for the lower-priced products. We estimate a search model with Dirichlet priors, on a dataset of prices and market shares of S&P 500 mutual funds. We find that the assumption of no uncertainty in consumer priors leads to substantial biases in search cost estimates.

Keywords: dirichlet distribution, consumer search

Suggested Citation

Koulayev, Sergei, Search with Dirichlet Priors: Estimation and Implications for the Price Elasticity of Demand (September 14, 2013). Journal of Business and Economic Statistics, Volume 31, Issue 2, 2013. . Available at SSRN: https://ssrn.com/abstract=2660500

Sergei Koulayev (Contact Author)

Consumer Financial Protection Bureau ( email )

United States

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