Modeling Interdependent Consumer Preference
Introduction: In individual’s preference for an offering can be influenced by the preferences of others in many ways, ranging from the psychological benefits of social identification and inclusion to the benefits of network externalities. Yet models of unobserved heterogeneity using random effects specifications typically assume that draws from the mixing distribution are independently distributed.
If the preferences of an individual are dependent on the preferences of others, then it will be useful to incorporate these dependencies in our standard models. The challenge in modeling dependencies between consumers is to choose a flexible yet parsimonious model of dependence. That is, some structure must be imposed on the covariance across consumers in order to make the model tractable.
Background: Quantitative models of consumer purchase behavior often do not recognize that preferences and choices are interdependent. Economic models of choice typically assume that an individual’s latent utility is a function of brand and attribute preferences, not the preferences of others. Preferences are assumed to vary across consumers in a manner described either by exogenous covariates, such as demographics (for example, household income), or by independent draws from a mixing distribution in random effects models..
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