Modeling Quality as a Latent Variable: An Application to Environmental Valuation

To date, the valuation of environmental quality has been severely hampered by our ability to actually measure quality. Often environmental resources are described by exhaustive lists of attributes. Unfortunately, high multicollinearity among attributes leads to serious econometric problems. The use of too few attributes, on the other hand, leads to underspecification of the valuation model. Finally, it may be the case that measurable environmental attributes do not adequately describe the elements of environmental quality that consumers perceive. In this paper, we use a latent variable approach to address both the issue of multicollinearity in environmental (quality) attributes and the gap between measured and perceived attributes. JEL: D12, C25, Q20, Q26