Estimation of Preference Heterogeneity in Markets with Costly Search

53 Pages Posted: 17 Jul 2018 Last revised: 19 Nov 2020

See all articles by Ilya Morozov

Ilya Morozov

Stanford Graduate School of Business

Stephan Seiler

Imperial College Business School; Centre for Economic Policy Research

Xiaojing Dong

Santa Clara University

Liwen Hou

Shanghai Jiao Tong University (SJTU)

Date Written: November 18, 2020

Abstract

We study the estimation of preference heterogeneity in markets where consumers engage in costly search to learn product characteristics. Costly search amplifies the way consumer preferences translate into purchase probabilities, generating a seemingly large degree of preference heterogeneity. We develop a search model that allows for flexible preference heterogeneity and estimate its parameters using a unique panel dataset on the search and purchase behavior of consumers. The results reveal that when search costs are ignored, the model overestimates standard deviations of product intercepts by 53%. We show that the bias in heterogeneity estimates leads to incorrect inference about price elasticities and seller markups and has important consequences for personalized pricing.

Keywords: Consumer Search, Preference Heterogeneity, Choice Persistence, Pricing, Importance Sampling

JEL Classification: D12, D83, M31

Suggested Citation

Morozov, Ilya and Seiler, Stephan and Dong, Xiaojing and Hou, Liwen, Estimation of Preference Heterogeneity in Markets with Costly Search (November 18, 2020). Stanford University Graduate School of Business Research Paper No. 18-34, Available at SSRN: https://ssrn.com/abstract=3202534 or http://dx.doi.org/10.2139/ssrn.3202534

Ilya Morozov

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Stephan Seiler (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Centre for Economic Policy Research ( email )

London
United Kingdom

Xiaojing Dong

Santa Clara University ( email )

Santa Clara, CA 95053
United States

Liwen Hou

Shanghai Jiao Tong University (SJTU) ( email )

KoGuan Law School
Shanghai 200030, Shanghai 200052
China

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