Addressing Endogeneity in Discrete Choice Models: Assessing Control-Function and Latent-Variable Methods

Abstract

Endogeneity or nonorthogonality in discrete choice models occurs when the systematic part of the utility is correlated with the error term. Under this misspecification, the model's estimators are inconsistent. When endogeneity occurs at the level of each observation, the principal technique used to treat for it is the control-function method, where a function that accounts for the endogenous part of the error term is constructed and is then included as an additional variable in the choice model. Alternatively, the latent-variable method can also address endogeneity. In this case, the omitted quality attribute is considered as a latent variable and modeled as a function of observed variables and/or measured through indicators. The link between the controlfunction and the latent-variable methods in the correction for endogeneity has not been established in previous work. This paper analyzes the similarities and differences between a set of variations of both methods, establishes the formal link between them in the correction for endogeneity, and illustrates their properties using a Monte Carlo experiment. The paper concludes with suggestions for future lines of research in this area.

Citation

Guevara, C.A. and Ben-Akiva, M. (2010), "Addressing Endogeneity in Discrete Choice Models: Assessing Control-Function and Latent-Variable Methods", Hess, S. and Daly, A. (Ed.) Choice Modelling: The State-of-the-art and The State-of-practice, Emerald Group Publishing Limited, Leeds, pp. 353-370. https://doi.org/10.1108/9781849507738-016